Can you guess the most significant risk associated with investing?
Is it credit risk? Interest-rate risk? Inflation risk?
The answer is none of these. For most investors, the biggest risk is the risk of losing money. Financial loss can provoke such powerful and visceral reactions that it’s no surprise that some investors try to time the market – buying or selling investments based on future price predictions — in an attempt to get around that discomfort.
In most cases, when the markets are heading south, investors tend to only focus on whether they should sell. They think that unloading their investments and moving to cash might help them avoid further loss. But what many investors forget is that market timing actually consists of two parts: deciding when to sell and when to buy back.
As it turns out, investors are notoriously awful at both. Attempting to time the market to stanch the bleeding of their portfolios, many investors tend to miss out on periods of exceptional returns.
For instance, an investor who sold out of the U.S. stock market (as benchmarked by the S&P 500 Index) after a down year and waited until the market had rebounded with a “decent” year (up 10%) to buy back in would have significantly underperformed an investor who remained invested in the market through the last 30 years.
So, what are some of the best ways to combat the urge to attempt to time the market?
Know your investment goals and your timeline.
Most people invest in stocks and bonds to steadily build and preserve wealth over decades. An appropriate long-term investment strategy doesn’t include jumping in and out of the market based on its short-term performance. In the near term, it’s no surprise to see sharp spikes in stock prices, but over long periods of time, the stock market can be remarkably steady.
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Second, understand why market timing is so risky.
Over the last 30 years, an investor who missed out on the best three months of performance in the S&P 500 Index would have seen their average annual return fall by more than 1% over the full investment period. While this sounds like a miniscule amount, it will make a significant difference over a long investment horizon.
Similarly, an investor who was out of the S&P 500 Index during its best six months of performance will lose more than 2% of their annualized return over that same 30-year period.
Finally, work with a financial advisor.
Market timing can seriously undermine long-term investment performance. If you work with an experienced financial advisor, he or she can help you build a portfolio that is appropriate for your goals, risk tolerance and timeframe. Your advisor can also be a voice of reason and reassurance during the inevitable rocky times in the market.
If you’d like to get a second opinion on your portfolio with no cost or obligation, click here to schedule an appointment with one of our financial advisors.