If you want an example of the futility of following the strategy that you appear bent on pursuing — i.e., timing the market, or jumping out of the stock market to avoid downturns and then jumping back in to reap stocks’ gains — you need look no further than last year.
As you may remember, 2016 got off to a terrible start. The Standard & Poor’s 500 index fell 5% in January and by the first week or so of February was down more than 10%. At this point, many investors were concerned that stocks could be in for a major rout. Far from slipping into correction or bear-market territory, however, the market rallied and by early June was up about 4% from the beginning of the year.
Then came the hysteria surrounding Brexit. Convinced that British voters’ decision on June 23rd to leave the European Union would lead to financial Armageddon, panicked investors stampeded out of stocks, driving the market down more than 5% in the two trading days following the referendum. But the predictions of Brexit ushering in a deep slump proved wrong, and within weeks the stock market had not only recovered its post-Brexit loss but was up 7% from the end of the previous year.
But perhaps the biggest scare in 2016 for stock investors was the election of Donald Trump. This was the event that was absolutely, positively supposed to trigger a significant setback in stock prices. Two economists — Justin Wolters of the University of Michigan and Eric Zitzewitz of Dartmouth — published a paper prior to the election that estimated a Trump win could send stock prices down 10% to 15% in the U. S. and around the globe. And in an election-night blog post he wrote when it became evident that Trump had defeated Hillary, New York Times columnist and Nobel Laureate economist Paul Krugman noted that «markets are plunging» and said his «first-pass» estimate of when they would recover was «never» (although he retracted and revised that call in another post two days later).
Of course, the market climbed almost 5% between Trump’s election and the end of the year. And despite all the doomsaying throughout the year, the assurances that stocks were soon to be on the rocks, the S&P 500 ended the year with a return of just under 12%, including dividends.
Related: Should I invest $1 million of my retirement savings in an annuity?
I’m not suggesting that you should necessarily ignore the prognostications of putative stock market seers. But I am saying that you’re generally better off not acting on them, whether the predictions warn of dire times ahead or herald robust gains. Fact is, forecasting short-term moves in the financial markets is largely a guessing game. I’m sure stocks will get hammered some time in the future, just as they’ve been many times in the past. (You can see what sort of damage has been inflicted in corrections and bear markets since 1929 by checking out this compendium of S&P 500 bull and bear markets from Yardeni Research.) But pinpointing when those downturns will come is another matter. No one’s crystal ball is clear enough to do that consistently.
So how does all this relate to your question? Simple. It shows that you shouldn’t be trying to guess when to move in and out of the stock market (or the bond market , for that matter) in the first place. When it comes to your retirement savings or any other money you’re investing for the long-term, you’re much better off creating a mix of stocks and bonds that you’ll feel comfortable sticking with through good markets and bad.
Yes, taking this approach means you’ll periodically have to ride out some downdrafts in the market. But it will also ensure that you’ll have money invested in stocks when the market is climbing (which, over the long run, is more often the case).
Ideally, when you build that mix of stocks and bonds, you want to have enough in stocks to generate the returns you’ll need to help you achieve your financial goals, such as building a retirement stash or spending down your nest egg in retirement without depleting your assets too soon. But you also want to have enough in bonds to provide some downside protection so that you don’t panic and sell your stocks when the market goes into a slump.
You can arrive at a risk-vs.-reward ratio that’s right for you by going to a risk tolerance-asset allocation calculator like the free version Vanguard offers online. The calculator will suggest an appropriate blend of stocks and bonds. If you click on the link that says «other allocation mixes,» you’ll see how your recommended portfolio as well as other blends of stocks and bonds have performed over the long term as well as in good and bad years.
To get a sense of how that recommended mix of stocks and bonds as well as others might affect the eventual size of your retirement stash given how much you’re saving — or how long your stash is likely to last at different withdrawal rates after you retire — I suggest you also rev up a good retirement income calculator like the one in the Tools & Calculators section of RealDealRetirement’s Retirement Toolbox.
As to your question of how and when you should get back into the market, my answer is simple: Once you’ve decided on a stocks-bonds mix that’s right for you, you should go to that mix pretty much immediately. I know that most personal finance columnists and many advisers would recommend that you dollar-cost-average your way to your target portfolio. For example, if you have $120,000 in cash and have decided after going through the process I described above that a mix of 50% stocks and 50% bonds is right for you, many people would advise you to take $10,000 each month from cash and invest half of it in stocks and half in bonds until you’ve hit your target $60,000 in stocks and $60,000 in bonds at the end of a year. (For simplicity’s sake in this example, I’m leaving out any returns your money might earn over the course of the 12 months.)
But what you’ve really done by dollar-cost averaging is take more time to get to the mix of stocks and bonds you’ve decided is right for you (50-50 in this example).
