What if you invested at the worst possible point in the market every year for 20 years? You will be surprised at the outcome.
Wow.
See if you're as surprised as I was by the findings of a US study about market timing from the folks at Schwab. They looked at five different styles of investors, assuming that each started with $2,000 to invest every year for the 20 years ending in 2007. Each invested in the S&P 500 index in the US, and held on until 2007. Here are the five investing styles; see if you recognize yourself in any of them:
- One invested the entire sum immediately upon receipt, at the beginning of each year.
- One dollar-cost averaged into the market, investing one-12th of the $2,000 each month. Many people like this approach, as discussed in this recent article.
- One had perfect timing, investing one-12th of her $2,000 at the best time of each month.
- One had lousy timing, investing his sum at the worst possible point in each year, the point at which the market was at its highest.
- And one just didn't invest at all, leaving all his money in cash. (The study used Treasury bills as a proxy for cash.)
I suspect that most of us can identify with most of these types. We often try to time the market perfectly, usually falling short. We wait just another day, just another week, and so on, hoping to get a more perfect price. Then we end up either investing at a higher price, or not at all, putting our purchase off even further.
Predictions and Results
So how do you think each investor did over the 20 years? I think it's easy to assume that the perfect timer reaped the highest rewards, and the worst timer the lowest. You might also assume that the dollar-cost averager outperformed the immediate investor, since investing immediately could have you in the market at suboptimal points.
Well, check out these results:
| The investor who ... | Ended up with ... |
| Had perfect timing | $135,915 |
| Invested immediately | $132,126 |
| Dollar-cost averaged | $126,974 |
| Had the worst timing | $117,737 |
| Never invested | $61,502 |
So yes, we were right about the perfect timer. But here's a news flash -- she doesn't exist! No one can time the market perfectly every year. It hasn't happened and probably never will.
The next interesting point is that the immediate investor performed nearly as well as the perfect timer and outperformed the dollar-cost averager. If true, this is good news for us if we choose to adopt this style, because it's an easier -- and cheaper -- approach than paying commissions to execute a dozen trades.
Finally, look at the worst-timing investor. You might think he'd do terribly, perhaps even losing money over time. But no -- he almost doubled the performance of the fellow who never got around to investing. Think about that. It suggests that we can invest in the market at the worst possible times each year, and still do well.
And you know -- that performance is really pretty good. The final tally is only 13% lower than the perfect timer. That comes out to less than 1 percentage point of annual returns. So don't spend too much time worrying about finding the right time, or kicking yourself for having bought into the market at what seems like a regrettable point.
Counterarguments
Some might argue that this study -- which ended in 2007, prior to last year's market crash -- ignores some important data. I concede that, all things being equal, buying low is the best thing to do, which is why recessions such as this one present fantastic investment opportunities.
But get this: The researchers repeated their study over 63 20-year periods since 1955, as well as 30-, 40- and 50-year time frames. The result? "In every 30-, 40- and 50-year period, perfect timing was first, followed by investing immediately or [in a few instances] dollar-cost averaging, bad timing and, finally, never buying stocks."
What To Do
So think about these results, and see if you want to change any of your investing practices.
While you shouldn't ignore valuation, the Schwab study teaches us that correct market timing is of limited importance, so, if you're going to buy individual stocks, it's far better to spend your energy choosing the right stocks rather than worrying about where the market is heading next.
Take, for example, these large, steady, dividend paying companies. Over time, from these relatively low valuations, they should be able to generate above average returns in the coming years and even decades.
Of course, these aren't official recommendations, but they might be interesting starting points for further research.
But once you find solid, healthy, growing, undervalued companies, consider buying into them sooner rather than later, or at least pound-cost averaging into them, perhaps by buying in thirds over a few months. As the Schwab study indicates, waiting for the perfect time might hurt your ultimate performance.
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More on the economy and the markets:
> A version of this article was originally published on Fool.com. It has been updated by Bruce Jackson. He doesn't have an interest in any of the companies mentioned in this article.
