When seeing stock market charts and business news headlines, it can be tempting to imagine striking it rich by timing investments perfectly. In reality, figuring out when to buy or sell stocks is extremely difficult. Both professional and at-home investors make serious mistakes when trying to time their market entrance or exit.
In 2020, retail investors returned to the stock market in a big way: U.S. households bought $211 billion in individual stocks, the highest level in six years, according to Federal Reserve data. That’s after years of stock ownership being down, particularly among younger Americans, after the 2008 financial crisis.
While sometimes volatile and risky, the stock market has historically been a consistent way for Americans to build wealth. The average annual stock market return based on the benchmark S&P 500 Index has been 10%, data going back to 1926 show. That means if someone is stashing away a lot of cash, they’re missing out on potential returns.
But waiting for the “right time” to jump into the market is a losing strategy. Read on to learn why timing the market is not the way to go and some better ways to invest.
Why Timing the Stock Market Doesn’t Work
Waiting to invest could cost an individual thousands of dollars over their lifetime. It’s also important to know that by leaving money in a checking or savings account, a person is not protecting their money from inflation risk. That’s because the value of that cash in a checking or savings account erodes if the prices of goods and services increase.
Meanwhile, stock market timing is incredibly complex. Stock market prices can be influenced by global macroeconomic events, political events in a country, developments in specific industries or companies, as well as the sentiment of investors as a collective.
Even professional investors struggle to “beat the market”–outperform their benchmark stock index. A March 2021 S&P Dow Jones Indices report showed that for the 11 years through 2020, the majority of large-cap fund managers lagged the S&P 500.
Fear and Greed in Investing
When investing, it’s also important not to let two key emotions–fear and greed–drive decisions. That means if the stock market is plummeting, investors may be fearful, but they can’t let those feelings push them toward a decision to sell. That could cause them to “lock in” losses. There’s even a Fear and Greed Index that investors sometimes use to make contrarian decisions.
Take for instance what happened during the 2008 financial crisis. After Lehman Brothers Holdings Inc. filed for bankruptcy in September 2008, the stock market entered a tumultuous stretch. The S&P 500 finally bottomed on March 9, 2009. However, the index eventually regained all its losses in the course of roughly the next four years. Investors who had hung on likely may have recovered their losses.
Meanwhile, greed can cause investors to make poor decisions as well. For instance, during the tech bubble, investors bought into many newly public Internet companies without always doing the research. Some of these stocks weren’t even turning a profit, making their businesses vulnerable to going belly up. Ultimately, many at-home investors suffered losses when the dot-com bubble burst.
Of course there are no guarantees when it comes to investing. There’s always risk and volatility involved. However, one of the most tried and true methods for building wealth has been a buy-and-hold strategy when it comes to stock investing.
Why the Time to Invest Is Now
Ask any financial advisor: One of the most important predictors of your returns is the length of time you’ve invested in the stock market. While it’s difficult to predict what the market will do in the near future, an investor can get a better sense over the long term.
When an investor lets their money grow, it has the chance to weather short-term ups and downs and grow over time. On average, the S&P 500, often used as a market benchmark, has grown 7% a year after adjusting for inflation. That doesn’t mean a person can predict what will happen this year, or even in the next 10 years, but looking at long term trends can give them a better sense of market dynamics.
An individual might put off investing because they want to pay off all debts first or achieve other goals, like buying a house. In some cases, that might be true, like paying off high-interest credit cards or saving for a short-term goal, such as a three to six-month emergency fund.
But once a person has an emergency fund and is out of credit card debt, they should consider investing, even if they have a mortgage or student loan debt. Even if they’re only investing for retirement, it’s a good idea to start now.
Consider Investing as Early as Possible
The younger you are when you invest, the better. For example, imagine Person A invests $200 a month in a retirement account starting at age 25.
Person B invests the same amount starting at age 35. They both continue to add $200 a month to their account. When they both retire at age 65, Person A will have almost twice as much as Person B: $306,689, compared to $167,550, assuming a 6% rate of return, 2% inflation rate, and 15% tax rate.
That’s true even though Person A only contributed 33% more to her account. This is how compound interest grows investments, or the power of how earnings from one’s investments can continue to build wealth.
Percentage of Retail Investors in Stock Market
As mentioned, after the 2008 financial crisis, many people were reluctant to invest in the stock market. That changed steadily in the run-up to the Covid-19 pandemic and dramatically in 2020, when quarantine measures to contain the virus kept everybody at home.
Retail-investor participation in the U.S. stock market jumped 23% in February 2021 from 20% in 2020, according to estimates by Bloomberg Intelligence. That’s also up from 15% in 2019 and double the level in 2010.
Furthermore, while the total equity volume rose 55% in 2020 compared with the prior year, the value of stocks traded only rose 49%. That signals more lower-priced stocks were being traded, which is an indication of retail investor participation since bigger institutional investors don’t tend to be as interested in that segment of the market.
Younger investors are jumping into the stock market. Some online brokerage firms reported that many of the investors who opened new accounts were under 40.
Furthermore, Americans showed discipline during the market volatility of early 2020, when the pandemic first whipsawed stock prices. Only 5.6% of people enrolled in a 401(k) plan changed their portfolio allocation in the first quarter of 2020, according to a Morningstar analysis. That’s a sign individual investors didn’t panic and sell their holdings at the worst possible time.
The Takeaway
If an individual is skittish about investing, their anxiety makes sense in light of the dramatic market ups and downs many have witnessed in the past two decades. But trying to time the market doesn’t work. Instead, investing in a diversified portfolio can be a good step toward building individual wealth.
On SoFi Invest, users can invest in thousands of assets from company stocks, exchange-traded funds (ETFs) to fractional shares on the Active Investing platform. For those who want a hands-off approach, the Automated Investing service will build and rebalance an investor’s portfolio for them without any management costs.
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