When you begin your investing journey, you may want to consider which strategy you’ll use. If you pay close attention to market reports, you’ll know that stock values fluctuate all the time.
One option investors may consider is timing the market in a way that maximizes their earnings, which is a complex investing strategy that's not guaranteed to work.
If you’re wondering whether you should try to time the market or stay the course, here are the options you'll need to consider.
What Does It Really Mean to Time the Market?
Timing the market is when you attempt to beat the stock market by predicting its movements and using this as a basis to buy and sell stocks.
When the market is down and stocks are cheap, you may want to consider investing in a well-known company’s stock. However, once you start trying to predict the best time to sell or end up selling too soon or too often, you’re starting to time the market.
Timing the market is more hands-on and completely opposite from the common buy-and-hold strategy you may consider when investing in a range of mutual funds and index funds.
It’s important to realize that no one can successfully predict the future of the stock market each time and whether you decide to time the market or not, investing still puts your money at risk.
But could timing the stock market actually make things worse for your savings? A 2017 study shows attempting to time the market may even hurt your portfolio’s performance. Still, there are some investors who advocate for timing the market, so let’s weigh some of the pros and cons.
Potential Benefits of Trying to Time the Market
At first glance, timing the market can seem like a strategic way to invest. If you want to buy low and sell high, you can certainly get more bang for your buck. The main benefit that draws people to this strategy is that there is an opportunity for large profits.
Timing the market requires a lot of hands-on work and analysis. You may notice certain trends that can aid your predictions and help you limit losses. There’s also the ability to limit the effects of volatility. When the stock market drops and you’re just holding on to your investments for the long-run, there’s not much you can do. Timing the stock market can make you feel like you’re taking more action and taking advantage of short-term price movement.
However, this strategy is often best considered for short-term trading and not someone who is looking to invest for the long-haul.
Disadvantages of Timing the Market
Timing the market comes with no guarantees but quite a few potential disadvantages. If your time is already limited, you may not like having to keep a constant eye on stocks and even check in daily to see how the market is doing.
There’s also the added expense from transaction costs and commissions. The more you trade, the more you may have to pay in fees as opposed to holding onto your stocks long-term. On top of that, you will also pay more taxes on your short-term capital gains. Short-term gains taxes occur when you sell an appreciated security (investments that have increased in value since you purchased them) that you’ve been holding onto for less than a year.
While long-term gains can be taxed at a maximum of around 20%, short-term capital gains are taxed as ordinary income at graduated tax rates. In order to win financially by timing the market, your gains (after taxes and fees) would need to outperform the index year after year which is extremely difficult to do.
Dollar-cost averaging is a common investment strategy that can be a great alternative to trying to time the market. With dollar-cost averaging (DCA), you are committing to invest the same amount of money regardless of market conditions. As a result, you won’t need to worry about trying to time things at the perfect moment.
This is a long-term strategy that you may already be using especially if you invest in your employer-sponsored 401(k). Each time you get paid from work, a fixed amount of your income goes into your 401(k) and is invested regardless of what’s going on in the market. If you earn a salary of $75,000 per year and contribute 20% toward your 401(k), that means you’ll invest $15,000. Imagine if you took that $15,000 and invested it all at once in one stock then tried to sell and trade based on what you thought was going to happen in the market. This would be a risky strategy that could cause you to end up losing your starting investment if the of that single stock drops significantly.
However, by breaking that $15,000 amount down into fixed monthly contributions, you can better shield yourself from devastating losses by not putting all your eggs into one basket. You can do the same with your other investment accounts as well.
Value averaging is another strategy that may be more promising than timing the market. With value averaging, you aim to invest more when the share price falls and less when the share price rises. Think of it as waiting for a good sale to occur before spending your money. Unlike with dollar-cost averaging, you won’t always be investing the same amount each month.
Market corrections are bound to happen, and if you want to buy stocks at a lower value in the hopes that they will increase over time, you do have the option to wait for the right opportunity.
With value-averaging, you’ll set a growth goal for your portfolio by calculating the realistic values of the investments in future periods. Then, you’ll make contributions each month based on that goal. For example, let’s say you have $3,000 invested and you want your nest egg to grow by $300 each month. If market increases only get your account to $3,050 in a month’s time, you’ll invest $250 to meet your goal. When the market does perform better and naturally meets your target goal, you’ll invest less of your own money during those months.
What Investment Strategy Should You Choose?
So how do you determine if timing the market or time spent in the market is more important to you? Start by assessing your goals and desired risk level. How much do you know about market trends? Even then, do you feel confident with predicting what’s going to happen tomorrow or next year? Most people don’t and when they do the math, they find that short-term capital gains taxes and trading fees add up.
If you are just starting out with investing or have many more years to go until you consider retiring, you may find it better to keep a low to moderate risk level and take advantage of long-term compound interest growth, which is inevitable.
Talk to a financial advisor for advice specific to your unique situation to ensure you make sound investment decisions that you’ll be pleased with in the future.