Getting into investing can be a nerve wracking thing, especially if you have never placed your money into the markets before and are accustomed to simply saving in a bank account. The number one question often asked just before investing is probably "what if the stock markets crash right after I put my money in?"
Over the long run the major market indexes that track a diversified range of companies, such as the S&P 500, tend to rise in value. Market crashes and downturns will inevitably happen, but it's impossible to tell when they will happen. Therefore those who have consistently invested their money and remained invested for the long term have ultimately been the winners.
But let's be honest here, if you've got some money saved up in your bank account - and you're not in a massive amount of debt - then you're not doing that badly all things considered. But you want to take your finances to the next stage and one of the more obvious things to consider is investments.
But when do you get in?
To sum up 2020 in the investing world, it was quite the wild ride. The S&P 500 started the year at a price of 3,230.78 - the closing price of 31 Dec 2019 - and ended at a price of 3,756.07 on 31 Dec 2020.
This represents a 16.26% return for the year, which is double the long term average of around 7% or 8%. However, this year on year increase isn't what's remarkable; after all, the market has risen by this sort of percentage amount within a 365 day period many times in the past.
What's truly remarkable is that the index fell from 3,386.15 on 19 Feb 2020 - the all time high at the time - to a low of 2,237.4 on 23 Mar 2020. A drop of around 34% in the space of just over a month. But it still ended the year up, as already mentioned.
The Dow Jones Industrial Average, another major index representing US companies - saw the second biggest one day drop in percentage terms, 12.93%. This drop surpasses Black Monday of the 1929 Wall Street Crash, a crash that signalled the beginning of the Great Depression.
Despite this, the markets were officially back into bull market territory by April and the S&P 500 had closed at a new all time high of 3,389.78 on 18 Aug 2020.
With such moves in such short amounts of times, any investor be they new or experienced might wonder if they had missed the boat. They may also wonder if the best thing to do with their money at the moment is to wait it out for the next crash to happen before getting in.
What does history say?
Typically for a bear market to occur there needs to be a 20% decline or more in the overall market (such as the S&P 500), and this decline needs to be sustained.
In our analysis let's look at any decline in the S&P 500 since 1929 that is of 15% or more, meaning we'll be looking at more than just the bear markets, and see what happens if we had invested money after the markets had recovered and then made a new all time high.
Remember, investing is a long term game and not something for quick profits within 1 or 2 years, so it's important to take a longer view of things. Usually the minimum time frame for an investment to be considered "long term" is 5 years, but the longer the better (as you will see).
The table shows non inflation-adjusted data starting off with the recovery after the crash of 1929.
The "Buy In Price" would be the new all time high at the time and we are going to imagine this is the price we had to buy at the time to begin our investment journey. The following three columns in the table then show the performance after 5 years, 10 years and 15 years.
If you were around during the 1950's and had only saved up enough money to invest after the stock market had recovered, in this case in September 1954, you might have thought at the time that you had missed the boat.
Because the chart would have looked like this:
The new all time high of $32.31 (dollars because the S&P 500 is a US index) might have made you pause and wonder if it was better to wait for a market correction.
For reference, $32.31 back then is equivalent to about $312.57 in today's money.
However as you can see from the above table, if you decided to go for it anyway and keep a long term mindset you would have done quite well. After 5 years your investment in at the price of $32.31 would have seen a return of 76.04%, and after 10 years you would have been looking at 160.54%.
That in turn would have grown to a return of 188.21% after 15 years which means your $32.31 would have become $93.12. Not bad for getting in at the all time high right?
Here's another observation I had when looking at the charts - and you can, and should, take a look at this yourself - if you didn't get in at $32.31 you never would have had the chance again, ever.
Once it reached that all time high it kept rising and never looked back.
Obviously there are cases in history where the price does drop a little but the point is "how do you know that's going to happen?" and "how long are you going to wait and see?".
Looking at the 15 year column in the table you can see that in all cases you would have made a profit, no matter which all time high you invested in.
On shorter timeframes - 5 years and 10 years - there are occasions where you would have gone negative, but take a closer look at the percentage numbers.
The biggest percentage drop you would have been seeing after 5 years is -14.39%, if you had invested in at the new all time high on May 2007. But on the more likely occasion where you were seeing positive returns, those percentages would have been in the 30s, 40s, 50s or more - with one exception which would've given you 14.53%, which still isn't bad.
The point is only enhanced when looking at the 10 year timeframe where you would have only seen negative numbers on one occasion, -22.98%. This is if you had invested in at the new all time high on November 1998.
Admittedly, while it does appear scary to think that your money would be worth almost 23% less after 10 years, this period includes two major market crashes - the dot com bubble and the 2008 financial crisis.
You're sort of hit with a double whammy and your timing on getting into the market - Reminder to never time the market! - is basically as bad as it could have been. But even still, you're only looking at a drop of 22.98%.
Give it another 5 years - since we're in this for the long term - and you would've been up by 55.19% on the original investment. To make this clear, you would have recovered that 22.98% that you were losing and then added 55.19% more.
Not bad considering you almost couldn't have got in at a worse time.
Taking the focus away from this particular occasion, if you look at all of the other 10 year performances you will also notice that most of them are offering you returns of over 100%, some even over 200%.
From an "odds" perspective I'd say that the small chance of a little bit of red is worth the relatively high chance that I'd see a rather handsome, and often considerably larger, return - especially if that red is only temporary and the green is all but guaranteed in the long run.
Time is the real hero of investing
In all of the above examples the assumption was that we decided to buy in immediately after the markets had recovered from a crash of at least 15%, and not a single moment later.
But as mentioned towards the start of this article, the new all time high that was made this time around was back in August of 2020 at 3,389.78. This means the price of 3,756.07 at the end of 2020 would almost be 11% higher.
Does that make a difference?
Well, yes - there's no avoiding that fact since you'll be buying in at an even higher price than the new all time high that was made post-crash.
But the difference isn't really that much when we look at the bigger picture. If we assume that we bought in at a price that was 11% higher than what we did in all of the earlier examples, only two instances turn from green to red.
These are the 10 year performances for the new all time highs made on April 1967 and May 1972. Take a look:
Now it needs to be said that across the board the percentage returns are lower; that's to be expected considering you got in at a higher price.
But look at all that green that's still in the table.
Look at the November 1998 long term performance - The one where you get hit by a double whammy - even if you got in 11% higher it's still the same in terms of colour coding, you see red initially but you're back in the green eventually.
It hardly paints a picture of doom and gloom for your money when thinking about getting in after a new all time high is made, or even later.
In fact, the way you could think about it is that if the market is up by 11% after making a new all time high, doesn't that suggest that the market is going strong and you should be in it?
Think back to that price of $32.31 in September 1954; if you didn't take it then you would have missed your chance, as already mentioned. Do you know what would have happened if you didn't buy the price that was 11% higher ($35.54)?
You guessed it, you never would have got the chance again.
We all like to think of ourselves as someone who has a better chance than others of "getting it right" when it comes to picking the perfect moment for getting into the market. Just like how most people think they're better than average at driving.
The reality is that we're just trying to be the "hero" of our own investment story, so that we can tell others how we managed to "read the market" or something along those lines.
From experience, this hardly ever works out. It's more likely that we'll miss opportunities or cause ourselves undue stress and panic when we realise that we can't read the market and that yesterday's chances are potentially slipping away.
Let time be the hero, so that you can be the winner instead.
Consistency, Discipline and Patience
I will point out that in a few cases when you get in at the new all time high you will see a period of negative performance. Usually it will be in the earlier years but, as we already saw in the example tables above, sometimes the negative performance can be drawn out a bit longer.
And despite the $32.31 example where the price never looks back, you will sometimes get cases where things look good early on and you see positive returns, only for the price to come back down and put you temporarily into the negative.
This is simply the nature of the markets and it is impossible to avoid it, unless you can see the future, so stop worrying about it.
It should also be pointed out that the earlier examples assume you only ever get in at one single price point - it's like you either bought in at $32.31 on September 1954 or not at all. Almost like a rare comet that becomes visible to the naked eye on a particular night, you either take your chance to see it or you miss it forever.
But this isn't how investing happens, or at least it doesn't have to happen this way - what's more likely is that you'll periodically have a bit of money, maybe every month after you get your paycheck, and some of that will be available for you to invest.
That would mean not only will you be able to buy in September, but also in October, November, December, January and on and on and on.
What does this mean?
It means you're going to be buying in at a lot of different prices because the market is always moving no matter what.
So stop overthinking about what the price is right now
Some of your buys will perform well immediately - like $32.31 in September 1954 - and some of your buys will take a little bit of time to come through - like November 1998.
But if you are consistently buying every month (or every few months if that's what suits you better), and if you're being disciplined by not trying to "be the hero", then your good prices will average out the bad prices and they will all be profitable in the long run.
Be patient with your investments and give it time - this can't be repeated enough times.
A quick example is if you buy one share at $10 in September, $11 in November, $13 in December, $11 again in January, and $15 in February then you will have paid $60 in total for 5 units. This means each of your shares is worth $12 on average (divide $60 by 5).
It doesn't matter that you paid a "high" of $15 in the latest purchase (February) because on average you're actually in the market at a lower price when you take into account all of your previous purchases.
This is known as unit cost averaging (or dollar cost averaging) and I covered it with more detail and examples in "How to always buy the S&P 500 at a low price".
Oh, and when the price rises in the future to $16 or $17 or more, every share you bought would be considered "cheap".
Maybe that "rare" comet wasn't so rare after all, maybe there was a meteor shower.
I always feel like there's so much more to talk about whenever writing out a particular thought - like reminding you about diversification because the examples in this article focused on the US markets (since it represents a significant portion of the global economy) and you don't know which regions in particular will perform well and which ones won't.
Or going into some of the psychology behind the Market Timing Trap to highlight some potential thought processes - based on my own experiences - that may happen when you're trying to be the hero.
But there's always future opportunities for me to expand on such thoughts in later articles.
So for this article I'll simply wrap up by reassuring you that while it can be nerve wracking to buy the markets at a high - especially if you're new to investing, and that feeling is normal - history has shown that anyone who "took the dive" has ultimately soared.
Final note: As I publish this on the 8th of January the S&P 500 is even higher than the prices referred to in the article. But fear not, because the principle of "time in the market" beats "timing the market" always wins.
Hey - just one final word before wrapping up - If you're keen to consume more financial related writing then check out Dr FIRE's blog where you will find regular updates (typically Wednesday's) on interesting financial reads.