When you have money available to invest, it’s human nature to want to pick the “right” time to invest it. Yet, the reality is that no one can predict what the stock market is going to do in the short-term, and because of that it’s almost impossible to get the timing exactly right.
Considering the stock market’s wild ride recently, the question of timing is even more relevant than usual. If you’re someone with cash on the sidelines that you’ve been waiting to invest, one (or both) of these narratives might sound all too familiar:
From February 19th through March 23rd (when the S&P 500 fell by ~34%):
“I can’t invest now since the stock market is going down. I think the market will continue to fall, so I’ll wait until it stabilizes.”
From March 23rd through April 30th (when the S&P 500 rose by ~30%):
“I can’t invest now after the market has already gone up. I’ll wait until it goes down again.”
Instead of worrying about the “right” time to invest, a better approach is to step back and focus on your reason for investing in the first place. Asking the following questions can help reframe the issue from a more constructive point of view.
Why are you investing?
Before thinking about when to invest, you first need to know why you’re investing. In other words, what will the money ultimately be used for? The reason this is so important is that it provides the time horizon for your investment, which then gives the framework for making more specific decisions, such as how and when to invest the money.
The longer your time horizon, the less your timing matters. What the stock market will do over a given day, month, or year is highly uncertain, but what it will do over ten, twenty, or thirty years is much more predictable. This is why it makes sense to invest differently for long-term goals than for short-term goals.
How should you invest for long-term goals?
If you’re investing for a goal that’s ten or more years away, like retirement, it makes sense to invest money for that goal as soon as it becomes available. By following this disciplined approach, you’ll avoid making the mistake of trying to time the market and potentially missing out on upside.
The natural concern with this method is that you might invest the money, only to see the market then decline. While this is certainly possible, if you don’t need the money for a decade or more, does it really matter if the market falls over the coming days, weeks, or even months?
Historically, the stock market has gone up more often than it’s gone down, and while there’s no guarantee that this will continue in the future, the odds are in your favor. As the famous investor, Peter Lynch, once said, “Far more money has been lost by investors preparing for market corrections, or trying to anticipate corrections, than has been lost in the corrections themselves.”
How should you invest for short-term goals?
The more difficult question is how to approach things if you’re planning to use the money for a shorter-term goal, like a down payment for a house in a few years. How you invest for this type of goal will depend on your risk tolerance.
The safest approach is to save in cash, through something like a high-yield savings account. You might only earn ~1.5%, but at least you’ll know that return is guaranteed. On the other hand, if you want the potential to earn a higher return, you’ll have to take on more risk.
There’s no free lunch in investing and there tends to be a trade-off between risk (price volatility) and reward (investment return). Historically, stocks have returned ~10% while bonds have returned ~5%. However, stocks have also been much more volatile and there have been periods, such as February and March of this year, where stocks fell dramatically while bonds actually appreciated.
Therefore, when deciding how and when to invest available money for short-term goals, it’s best to match your investments with your risk tolerance. If you need the money in less than a year and you can’t afford to see it decline in value, it’s probably not worth the risk of investing in stocks or bonds. However, as your time horizon (and tolerance for volatility) increases, you can afford to take on more exposure to stocks and bonds, in the hope of earning a higher return.
Just as every investor would love to invest available cash when the stock market is at a low point, every investor would also love to avoid investing immediately before a stock market decline. Unfortunately, there’s no reliable way to predict when these declines will happen. Rather than trying to time the market, a better approach is to focus on why you’re investing. Answering that question will provide the time horizon for your investment, which will then determine when and how to invest the money you have on hand.
About MD Wealth Management: We are an Ann Arbor financial planner that specializes in providing financial planning for physicians and retirees. We are CERTIFIED FINANCIAL PLANNER™ professionals and fiduciary financial advisors who operate on a fee-only basis, which means we do not sell financial products or collect commissions. As an Ann Arbor financial advisor, we enjoy working with clients both locally and remotely.