Last week, a friend mentioned that he is expecting there will be a recession next year. He said he is saving money to invest when the market goes down.
He is probably right – there will be a recession next year. However, waiting for that to start investing is not a good idea. There are several reasons why market timing does not work; below are the top two:
1. Market bottoms well before the economy
The market is a forward-looking mechanism. If everyone thinks there will be a recession next year, then that news is already priced into the stock market. Said another way, the market is down because it has already factored in all the bad news – inflation, covid, recession, war, etc.
So for the market to go lower, there will have to be additional bad news that no one is predicting now. For example, if the recession lasts longer than people expect, the market may decline further.
During the global financial crisis of 2008 – 2009, the market went down significantly. However, in March 2009, the market started going up. No one was sure why – the economy was still in a recession, unemployment was high, and business news was lousy.
The recession ended later in 2009, but the market was already up 50% by that time. If someone had waited for the recession to end, they would have missed out on a lot of gains.
2. Most market gains happen in a few days
Surprisingly enough, not being invested even for a few days can mean your returns will be significantly less. Almost all the gains in the last 20 years came from 20 days! If someone was not invested for those 20 days, they made no money even if they were fully invested for the remaining days in those 20 years.
The average annual return for the last 20 years was 7.47%. But if you remove the best 20 days, the return drops to 0.69%.
In summary
No one can predict when the market will go up or when the best time to start investing. It is not wise to wait for the market to bottom before starting to invest.
I am doing nothing new in this market downturn. I have built a strong foundation and am regularly investing in a low-cost index fund every month.
The earlier two posts in this series can be found here (part 1) and here (part 2).