The classic question of every investor is how do I time the market to make sure I buy low and sell high? Check out the S & P index from the last 65 years. Close to the end of the 20th century, the issue was not so critical as ups and downs were more modest. But the market looks crazy in the 21st century. So what investing fundamental can I tell you about, to ensure you are buying in 1994, 2003 and 2009 while you sold off equities in 2000, 2003 and 2013? And just to mess with your thinking, this chart says selling off in 2013 was a good idea but the strange bull market continues into 2017!
The fact is that most investors sold off in 2001-2002 as the market fall got scary with no sign of bottom, as it did again in 2009, and only bought back into the market in 2005 to 2007, and in 2012, as most of the losses were regained. In other words they sold low and bought high! I am going to tell you how to beat the market.
My favourite pundit on market timing is Isaac Newton: “I can calculate the motion of the heavenly bodies, but not the madness of people” he said, after losing a fortune in the South Sea Bubble of 1720. If Isaac Newton could not time stock markets what hope do you have? That is the Bad News. But the good news is you do not need to buy low and sell high, you just need to keep buying!
Investing fundamental number three, after balance and diversification, is consistency, also called dollar-cost-averaging. Save the same 10% every month and do not worry about catching the market. When the market goes down, your same monthly dollars buy more shares. When the market recovers, as it always does, you end up owning more units of your investment. Let me show you. If you had $1200 to invest, which investment from the chart would you buy?
With investment A, your investment grows from $1200 to $2400. (Doubling in 12 years imputes a 6% annual return, according to Einstein). Investment B would have grown to $1800 and Investment C would have recovered to the original $1200 investment, a rate of return of zero.
But what if you invest $100 each period instead of the $1200 at the beginning? Now which investment would give you the best return?
Believe it or not, investment C would be the winner giving you a portfolio value of $1741.27 while steady investment A, and more volatile B, would both end up at about $1595. When investing regularly, dollar cost averaging works in your favour throughout the normal up and down cycles of the stock market.
Don’t believe me eh? Let’s break it down. With dollar cost averaging you systematically invest a fixed amount of money every period to buy investments that have a fluctuating price. Look at investment C as a fund with a starting price of $10 per unit. When prices drop as the market swings downward, rather than get concerned because the value of their portfolio drops, you and Stephen Harper systematically take advantage of “the buying opportunity” by buying more units of the same investment. You will finally be buying low! In this example, as the price drops in the first 7 months, more units are being bought each month for the same $100 invested.
|Dollar Cost Averaging|
|1||$ 100.00||$ 10.00||10.00||10.00||$ 100.00|
|2||$ 100.00||$ 9.00||11.11||21.11||$ 190.00|
|3||$ 100.00||$ 8.00||12.50||33.61||$ 268.89|
|4||$ 100.00||$ 7.00||14.29||47.90||$ 335.28|
|5||$ 100.00||$ 6.00||16.67||64.56||$ 387.38|
|6||$ 100.00||$ 5.00||20.00||84.56||$ 422.82|
|7||$ 100.00||$ 4.00||25.00||109.56||$ 438.25|
|8||$ 100.00||$ 6.00||16.67||126.23||$ 757.38|
|9||$ 100.00||$ 7.00||14.29||140.52||$ 983.61|
|10||$ 100.00||$ 8.00||12.50||153.02||$ 1,224.13|
|11||$ 100.00||$ 9.00||11.11||164.13||$ 1,477.14|
|12||$ 100.00||$ 10.00||10.00||174.13||$ 1,741.27|
At the end of twelve periods, with the market recovering in price to the original $10 per unit, your $1200 invested is now worth $1741.27. In fact when the market crashed in 2008, if you had kept buying equities through 2008 & 2009 your portfolio would be worth far more by 2010 than it was at the start of 2008 even though the “index” had only recovered to its pre-crash level. I do admit that watching this investment failing to match your contributions over the first eight months would need a strong stomach when it does not show a positive return till the ninth month.
That is why I suggest choosing wisely. Consider balance in your asset allocation, and diversify your portfolio, then keep buying consistently. Do not even look at the crazy ups and downs. Maybe once a year, consider tweaking your balance and your diversification, based on buying independent advice about macro trends. Outside of that, DON’T TOUCH IT. Dollar-cost-averaging will look after the market timing issue.
Fredrick Petrie, B. Comm. (Hons.), author of “THE END OF WORK: financial planning for people with better things to do”, provides financial education at www.navigatingfinance.com, reach him at email@example.com or call (204) 298-2900. You can get started at http://www.amazon.ca/END-WORK-Financial-Planning-People-ebook/dp/B00XCY0AJ2/