Every investor knows the adage to "buy low and sell high," but trying to time the market like that is harder than it sounds, and the margin for error is smaller than investors may realize.
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Over the 20-year period between 1996 and 2016, a substantial portion of the total market's return came from only a handful of days. And as no one can know ahead of time when such days will occur, trying to trade into them, or in anticipation of them, can mean missing out on steep upward moves.
Per an analysis by Calamos Investments, $10,000 invested in the S&P 500 (.SPX) at the start of 1996 would've grown to $43,930 by the end of 2016, assuming the investor took a buy-and-hold strategy. That's a strong annualized return of about 8.19%, although that return is below historical averages, given that period includes both the dot-com bubble bursting and the financial crisis.
Miss the five best days of that period, however, and the amount you're left with shrinks by more than a third, to $29,145, which represents annualized gains of 5.99% from the initial $10,000. The more "best days" you're not invested for, the worse off the end result looks. If you missed the top 30 sessions of that 20-year period, in fact, you would've lost money, with your initial $10,000 investment shrinking to a little over $9,000.
Obviously, missing the worst days would notably improve one's returns, but those are no easier to predict ahead of time.
According to Morningstar, there is a gap of 79 basis points between the returns of U.S. stock investors and the total returns of the funds they invest in. What that means is that investors lost 0.79% of potential returns due to their entering and (especially) exiting at the wrong time. For fixed-income investors, the gap was 73 basis points.
According to one study, the most active stock-market traders see about half the returns of their less active peers.
The potential downside of not being consistently invested is why financial advisers urge investors to buy stocks and them hold them for the extremely long term, ignoring market cycles and drawdowns and getting the benefit of compound interest.
As Barry Ritholtz, chairman and chief investment officer of Ritholtz Wealth Management, put it earlier this year, "If you don't want to invest in equities because you fear a market crash, then you should never be in equities, because equities always crash."
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