Equity market volatility can be anxiety-producing whenever it occurs, but perhaps never more than when it’s brought on by a jarring event such as the coronavirus. In these situations, the instinctive reaction can be to lighten stock exposure or delay putting in new money until the market hyperactivity subsides. Waiting for a supposedly opportune moment sounds appealing — in theory. But timing the market entails its own risks, as sitting on the sidelines can mean forgoing gains if share prices rebound.
The following three charts explore the risks involved in market timing and underscore the importance of sticking to a carefully thought-out financial game plan despite sometimes sharp market pullbacks.
Bear markets can arrive quickly and unexpectedly. But so, too, can rallies.
The chart below shows declines of 30% or more from the Great Depression to the global financial crisis. In that span, the S&P 500 jumped an average of 36% in the first three months after the index hit bottom, and 63% in the first 12 months. Thus far, a similar dynamic has emerged in the current bear market: After falling sharply in February and March, the index has since regained a notable chunk of ground.
Of course, it’s impossible to predict how stocks will fare in the current downturn. There is a clear risk that share prices could resume their decline, given the considerable economic and medical uncertainties surrounding COVID-19. Nevertheless, this chart underscores how difficult it is to predict when selloffs — and subsequent rallies — will occur.
It’s not just missing rallies that can damage long-term returns. It’s missing the relative handful of days with the most powerful gains.
The chart below shows the hypothetical result for someone who sat out the 10 best days in the S&P 500 over a 20-year period. That would have caused the investor’s compound return to shrivel from 5.6% to 2%.
Those 10 best days occurred during market recoveries. Sitting on the sidelines for the 20 best days would have erased the entire 5.6% gain, saddling the investor with a loss.
Now, consider an investor who faithfully put money into the market every year — but who had the most unfortunate timing.
The final chart shows the returns for three hypothetical investors, each of whom invested $50,000 annually for 30 years. Someone with the worst possible timing — in other words, someone who invested at the peak of the market every year — would have had $7.2 million after three decades.
That would have trailed someone with perfect timing, who invested at each year’s market low and ended with $9.1 million. But it would have far outdistanced the $2.1 million total for the person who remained in cash.
It’s always impossible to predict the market’s near-term direction, and the outlook is especially fuzzy today, given the enormous uncertainty surrounding the coronavirus. But as these charts highlight, timing the market can hinder long-term investment results.