How to Time the Market (Really)
Broad patterns tell you direction of the wind, where you want to sail.
Historically, average investment returns over the very long term (we're talking 40-70 years) have been some of the best available, but the seasons of the stock market tend to cycle with as much variability as Texas weather. The extremes and the inconsistencies are far greater than most realize. Let's examine the range of variability to truly appreciate the strength of the storms.
In the 103 years from 1900 through 2002, the annual change for the Dow Jones Industrial Average reflects a simple average gain of 7.2% per year. During that time, 63% of the years reflect positive returns, and 37% were negative. Only 5 of the years ended with changes between +5% and +10% - that's less than 5% of the time. Most of the years were far from average - many were sufficiently dramatic to drive an investor's pulse into lethal territory!
Almost 70% of the years were "double-digit years," when the stock market either rose or fell by more than 10%. To move out of "most" territory, the threshold increases to 16% - half of the past 103 years end with the stock market index either up or down more than 16%!
The simple fact is that the stock market rarely gives you an average year. The wild ride makes for those emotional investment experiences which are a primary cause of investment pain.
The stock market can be a very risky place to invest. The returns are highly erratic; the gains and losses are often inconsistent and unpredictable. The emotional responses to stock market volatility mean that most investors do not achieve the average stock market gains, as numerous studies clearly illustrate.
Not understanding how to manage the risk of the stock market, or even what the risks actually are, investors too often buy high and sell low, based upon raw emotion. They read the words in the account-opening forms that say the stock market presents significant opportunities for losses, and that the magnitude of the losses can be quite significant. But they focus on the research that says, "Over the long run, history has overcome interim setbacks and has delivered an average return of 10% including dividends" (or whatever the number du jour is, and ignoring bad stuff like inflation, taxes, and transaction costs).
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