Last year in November I wrote a blog post (Why I Stay Invested in Stocks?) about some investors (they were my friends) who were convinced that a market crash was imminent, and they were waiting on sidelines with cash to invest. Well, this is nearly the end of 2018 and that crash hadn’t happened yet. Of course, notwithstanding the market correction we’re going through now. But this is minor. Today the S&P 500 is down less than 10% from its peak.
At the time, the financial media was also hyping up the possibility of an imminent market crash. And people were clearly getting concerned about it. It wasn’t just my friends who were anticipating a crash. People were asking similar questions on social media and other forums.
That November I answered two questions on Quora on this “supposedly imminent” market crash this way:
I am not saying that I knew then that there won’t be a market crash in the next 12 months. I didn’t. Take another look at my responses above. I was advocating is that we investors need to focus on longer-term investing plans — rather than worry about some event that may or may not happen.
The stock market doesn’t behave predictably. I can’t consistently call the next market move. Same goes with so-called market pundits. They can’t consistently call the market direction either. It’s always possible to guess right occasionally. Think of it this way. If you flip a coin and guess which way it will land, you will be right about half of the time. You may get lucky and get two or three calls right in a row. But that doesn’t make you a seer. For instance, can you call ten coin tosses correctly in a row? I bet you can’t!
Even if I get lucky and pull out of the market before a crash occurrs — in other words I call a coin flip correctly once — how’d I know when to get back in? Can I make another coin flip call correctly? Remember for each successful market timing move, I need to make two correct calls in a row — one to get out and another to get back in.
If you study past market downturns, you’ll notice that general sentiment (among the media and casual investors) stay pessimistic long after the market turn around and start recovering. Take the last market drop of 2008 — 2009 period. Even as late as 2011 and 2012, the media was mostly publishing gloomy prospects for the market. In a previous post, I shared some of the headlines from that period. As the stock market gradually recovered off its lows, the media was still full of pessimistic headlines.
This is how it is in most down cycles. Popular media or regular investors are usually stuck in the recent past — watching the rear-view mirror while time moves forward. In this environment, do you believe you will be able to find the right time to jump back in the market? Most people don’t. Dalbar Inc. has studied mutual fund investors for decades. It reports that most investors underperform mutual funds’ performance by 3 to 6%. And roughly half of the difference can be attributed to investors’ own behavior — specifically panic selling, exuberant buying, and attempts at market timing.
Here’s a scenario from the past that we can look at. In the aftermath of the 2008 market crash, stocks sought to recover in 2009. But they dropped again by 28% by the middle of 2009. Most investors wanting to time the market would have bailed out by then. But by the end of 2009, the market had not only recovered but it had gained 23% for the whole year. Again in 2010, stocks went down 16% but recovered and gained 13% by the year-end. In 2011 and 2012, the market again dropped by double-digit percentage and still managed to recover all losses within a year.
Now think about investors who were trying to time the market at the time. How many of them do you think were able to correctly guess the market direction each time? Chances are none. It would have been equivalent to calling eight coin tosses correctly one after another.
A better question to answer as a would-be investor is the following: How much money do I have that I don’t need to consume for the next five or more years? Invest that money in stocks. You will come out fine at the end . And you wouldn’t be wasting any grey cells guessing which way the market is going next.
As for my friends who were expecting a crash this year, a couple of them are still waiting. And I am not sure if they will ever have the courage to dip a toe. They are not convinced that stocks can be profitable long-term investments. Another has given up on crash and found a financial advisor to invest with. He, I am afraid, is succumbing to the FOMO effect (Fear of Missing Out). Having stayed on sidelines for many years and watching the market move upward, he’s now capitulating when the market is probably in a late bull stage. I am not sure his investing plan will survive the next big market drop.
 Since 1950, the US stock market has never lost more than 3% in any rolling 5-year period. And a vast majority of times, it does so much better (with an average return of 11%).