Wait for a better market?

One of the most common questions I get … Should I wait until the market goes up before I make another contribution to my fill in the blank  … my IRA, 401k, 403b, individual account, joint account?

This is really a market timing question. And it ignores a truth about markets … they go up and they go down.

In the grand scheme of things, and there is some research that bears this out, that investing when you have the money (in other words don’t delay) provides a greater return historically compared to waiting until the market is up simply because returns are greater from a low point to a future point, relative to returns from a high point to that same future point by definition. Caveat … you must consider your time period discussed in the next paragraph too. And, past returns before you contribute are irrelevant since you can only get those returns going forward from the moment you invest. Buy low sounds good, but feels scary because that’s the moment the news feels worrisome. Indeed, at times there is panic in the air.

That is how “buy low” feels. It feels like there is less risk when things are going up … but that is when the risk is actually going up. What I mean is that the value of what you just invested (short term) is more likely to go down after a prolonged up trend in the markets. Investments made over the long term (many years earlier) are likely to have grown (but they too go down again in value relative to their previous peak). What I’m saying is that values go up and down over time. So expect that and don’t try to jump in and out of the market just because it goes up and down.*

Markets tend to trend up in the longer term since the other side of this blog’s argument is that markets do indeed go down too … however, the longer term trend has historically been up for the stock market. This upward bias changes over time with some time periods experience greater returns than others, and indeed when you begin to get to shorter periods, under 10 to 15 years depending on the era, the trend may be negative too. Past trends are known; future trends are not.

Back to investing when you have the money. Most people don’t have the money until they are paid and thus monthly contributions (Dollar Cost Averaging) are common for this reason. Sometimes, people receive inheritances, bonuses, or have savings they no longer need for a short term reason so they’re considering investing it as a lump sum (or split it into multiple investments? – No, for the the many reasons in this blog). When one invests, it should be for a long period of time. A long period of time allows the markets to go through its gyrations in the short term. There is no assurance any investment may grow over any period of time though … the very definition of risk. And Dollar Cost Averaging does not prevent loss.

The best frame of mind to have when making contributions is to expect the value to go down sometime … indeed many times … between when you contribute and when you withdraw. Making a decision for either contributions or withdrawals based simply on what the market has just done is likely to lead to loss due to behavioral factors and the simple truth that investing high and selling low certainly leads to loss by definition. You are likely to experience both bull and bear markets many times during your lifetime. Put yourself in a mindset to accept this. Allocate your portfolio so you regulate the highs and lows a bit more with asset classes that have less volatility relative to others; the combined effect overall is to reduce the total volatility** of the portfolio.

More on this for Pre-retirees.

How would this work for retirees?

*Risk is higher owning individual stocks as compared to indexed mutual funds (as compared to active funds or doing it yourself). Some even try to beat the markets (not possible over an extended period of time … and for retirement your assets are by definition “for an extended period of time).”

**Note: There exists volatility drag on returns; higher volatility actually reduces returns. The dilemma then is matching trying to get higher returns against the reality of actually receiving lower returns as a result of taking the higher risk. Returns are something nobody can directly control because nobody can control future events to achieve those returns. Only after events happen do we find out what the return was. Mixing many assets classes with different characteristics helps reduce volatility of the whole as compared to any volatility of any single ingredient.


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