the purposes of this exercise, let’s assume that the stock fund went back up to $20 a share one month after you did this.
In the first example, where you stopped investing in the stock market, your 10 shares at $20 would now be worth $200 and you would still have $200 in the stable-value fund. So in total you would have $400 in your account. You broke even.
In the second scenario, if you kept investing, you would now have 30 shares of the stock fund in your 401(k) that is now worth $20 a share. You would now have $600 in your account—a gain of $200 over what you invested.
In the first example, you are just back to where you started. In the second, you are up 50% on your money.
I realize this is an extreme example—there is no chance your stock investments will completely rebound in one month—but I wanted to make the point clearly that the right action to take over time is invest, invest, invest. As long as you have at least 10 years until you need this money, I am telling you to try to relax and have a long-term perspective when you open your statement and the value of your account has gone down. The more it goes down, the more shares you get to buy; the more shares you buy now, the bigger the payoff when the market goes back up. Please do not stop investing now. Don’t change your strategy—just change your point of view.
SITUATION: Your plan is to get out of stocks while they continue to go down, then shift your money back to stocks when things get better.
ACTION: What you are trying to do is “market timing.” In the short term, you may feel as if you are doing the right thing, but it will backfire on you over the long term. And retirement investing is all about the long term.
The big problem with market timing is that if you are out of the stock market, you run the very real risk that you will not be back in the marketwhen it rallies; there is no way you will ever make up for your losses if you miss those rallies.
Listen, I get where you’re coming from: It would be so great if we could sell before the markets go down and buy before the markets go back up, but it is nearly impossible to have perfect timing because there is no telling when the big rallies will come. For example, one day in an extremely wild period in October 2008, the Dow Jones Industrial Average lost nearly 700 points. Let’s say you got out of stocks that day because you had had enough. Well, two trading days later the Dow Jones Industrial Average skyrocketed more than 900 points. So you missed the rally that wiped out the losses from a few days earlier. Of course, that is a very rare and dramatic example; it’s not often we get such huge swings in the space of a few trading days. But the point is clear: If you try to time the markets, you risk missing out on rallies. That’s exactly what happened to so many investors who bailed out of stocks in late 2008 and early 2009 as the markets were suffering severe losses. But the sidelines were a costly place to seek refuge when the stock market posted a fast and furious 60% rally beginning in the spring of 2009. If you weren’t invested during that dramatic rally you lost the chance to earn back some of your bear market losses.
I know it is not fun or easy, but a long-term buy-and-hold strategy in a diversified mutual fund orexchange-traded fund (ETF) is what works best. Here’s some evidence to consider:
Let’s say you invested $1,000 in 1950 and then had perfect market timing and managed to miss the 20 worst months between 1950 and June 2008. Your $1,000 would have grown to more than $800,000, according to Toreador Research & Trading. But it’s not as if there is some public calendar that tells us exactly when to get in and out. So let’s take a look at what happens if you missed the 20 best months for stocks during that stretch—that is, you were in cash when the market rallied. Well, your $1,000 would have grown to just $11,500. If, instead, you had invested your $1,000 and