The Most Classic Mistake In Investing

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The second half of 2014 has been rough for stock market investors.

We’ve seen two violent sell-offs. The first came when the S&P 500 quickly tumbled 9.8% from its Sept. 19 all-time high of 2,019 to as low as 1,820 on Oct. 15. The second came the S&P tumbled 5.1% from 2,079 ion Dec. 5 to 1,972 on Dec. 16.

Because of the way our brains work, most of us worried about the possibility that this correction was turning into an outright market crash. Our instinct was to dump stocks. Surely, many investors sold and told themselves they would “wait out the volatility” on the sidelines.

However, history shows this is the most classic mistake investors make. So, kudos to those who held on to their long positions.

“Corrections are part and parcel of the investment process, they come and go, and it is imperative to take a deep breath and realize that what is most important for building wealth is not ‘timing’ the market but rather ‘time in’ the market,” David Rosenberg said on Oct. 14.

The S&P has surged back to record highs since Rosenberg made that prescient statement.

“Time in” the market is crucial, especially when things get scary for investors. There’s tons of data on this. We talk about it all of the time. Even the folks who sold the sell-off probably know about it. But let’s revisit some of the data anyway.

Missing A Few Good Days Will Destroy Your Long-Term Returns

When volatility picks up, it’s tempting to trade in and out of the market with the hope you’ll protect your wealth. Unfortunately, this increases the risk you’ll miss some of the best days in the market. And that can be very costly.

JPMorgan Asset Management illustrated how much an investor’s returns collapsed when they missed a few of the best days in the market. They found that if an investor stayed fully invested in the S&P 500 from 1993 to 2013, they would’ve had a 9.2% annualized return.

However, if trading resulted in missing just the ten best days during that same period, then those annualized returns would collapse to 5.4%.

cotd stock market missed returnsJP Morgan Asset Management

Missing these days do so much damage because those missed gains aren’t able to compound during the rest of the investment holding period.

“Plan to stay invested,” they recommend. “Trying to time the market is extremely difficult to do consistently. Market lows often result in emotional decision making. Investing for the long-term while managing volatility can result in a better outcome.”

The Best Days In The Market Come After The Worst Days

Some of the worst days in the market follow down days in the market. That seems to make sense intuitively.

However, some of the best single days in the market also follow some of the worst days. Here’s a table from Wikipedia putting the S&P 500′s 20 worst days next to 20 best days.

best daysWikipedia

This is just the nature of how the stock market moves. Bear markets don’t go straight down and bull markets don’t go straight up. When you look closely, they are marked by good and bad days, good and bad weeks, and so on. During periods of volatility, the magnitude of up-moves are just as big as the magnitude of down-moves.

 

Let’s Be Very Clear About Something…

We’re not proposing that we won’t see the stock market fall again tomorrow or the next day. We certainly can’t rule out the ever-present risk that the market could soon crash.

But, that’s just part of investing in the stock market. If you aren’t prepared to lose tremendous amounts of value, you shouldn’t be in stocks.

And once you’re in, you better be prepared for the volatility. Time and time again, investors aren’t willing to put their “time in” the market when the market has the most wealth to offer.

The above article is an extract of http://www.businessinsider.sg/investors-always-miss-rallies-charts-2014-12/?r=US#.VJyvrIAAJQ

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