Poorly Timed Selling Hurts Returns
The evidence is clear: Selling in bear markets can be extremely damaging to investors’ returns.
That’s because selling in downturns is, essentially, the opposite of ideal investment behavior. The ideal investor—or perfect market timer—would maximize returns by buying stocks when the prices are low (at market troughs) and, when ready to exit the market, selling only when prices are high (at market peaks).
Instead, however, most investors sell as markets fall and buy as they rise—indeed, it is this very behavior that drives rising and falling markets. By doing this, investors lock in losses at market troughs and, what’s worse, often miss out on market recoveries because the market’s best days typically follow its worst. Over the long term, this behavior can be extremely costly.
Consider, for example, research from Fidelity exploring the cost of missing the market’s best days. According to Fidelity, if an individual invested $10,000 in an S&P 500 index fund from January 1, 1980, to December 31, 2018, that person would have earned $695,515.3
However, should this hypothetical investor, instead of steadfastly remaining invested through thick and thin, attempt to time the market by buying and selling in response to market moves, their returns may be sharply curtailed. The chart below shows the cost of missing just a handful of the market’s best days during those 38 years (see Figure 3).
MISSING JUST THE MARKET’S FIVE BEST DAYS CUT THE VALUE OF THE PORTFOLIO BY
Similarly, Bank of America looked at market data going back to 1930 and found that, if an investor missed the 10 best trading days of every decade until 2020, that investor’s total return would be just 91%, compared to 14,962% for an investor who always remained invested for the full 90 years.4 In other words, being out of the markets is risky because you never know when you’re going to miss one of those “best days.”
MISSING THE TEN BEST TRADING DAYS EACH DECADE FROM 1930 TO 2020 REDUCED RETURNS FROM 14,962% TO 91%
In a further rebuke to attempts to time the market, research shows that even the upside of perfect market timing does not necessarily deliver dramatically better results than simply staying invested—especially when compared to the potential risk of poor timing. Charles Schwab, for example, simulated the performance of four different investors:
Peter Perfect, a perfect market timer who invested $2,000 each year at the lowest closing point from 2001 to 2020.
Matthew Monthly, who divided $2,000 into 12 equal portions, which he invested at the beginning of each month between 2001 and 2020.
Rosie Rotten, who had incredibly poor market timing and invested $2,000 each year at the market's peak from 2001 to 2020.
Ashley Action, who invested $2,000 on the first trading day of the year each year from 2001 to 2020.
Their respective performance illustrates the significant downside risk of attempting to time the market (see Figure 4).5 As you can see, Ashley Action and Matthew Monthly earned around $16,000 less than Peter Perfect, while Rosie Rotten earned over $30,000 less.
Since the evidence suggests that most investors act far more like Rosie Rotten than Peter Perfect when they attempt to time the market, staying invested is clearly the superior strategy.
Yet even though we have known for decades that staying invested is the wisest course, investors continue to abandon the markets when stocks fall. Why?
The answer is simple: Investors allow their emotions to drive their decisions. More specifically, during market downturns, investors sell due to a potent emotional force known as myopic loss aversion.
3 Fidelity. 6 Tips to Navigate Volatile Markets. June 2020.
4 Steelpeak Wealth. When You Sell During A Panic You May Miss The Market’s Best Days. March 13, 2020.
5 Charles Schwab. Does Market Timing Work? July 15, 2021.
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