The Cost of Staying on the Sidelines

The Cost of Staying on the Sidelines

November 29, 2022
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The Cost of Staying on the Sidelines

In the October edition of the Coastwise newsletter, we discussed the potentially large costs of trying to time the market – of being on the sidelines when inevitable material market rallies occur. Case in point, since the market lows in October, the S&P 500 has rallied nearly 13% and the DOW has exploded almost 20% to the upside. The NASDAQ 100 shot up nearly 10% in 2 trading days this month alone. These violent rallies occurred in the face of continued (albeit lower) inflation not seen in decades, an aggressive tightening Fed, and other economic challenges.


This hammers home the point: markets can rally, and rally hard, when you least expect it. Stock prices typically anticipate – at times months in advance – improving economic conditions. If you wait for the proverbial ‘all clear’ to put money back to work (having sold stocks at panic lows), then you will fall prey to mistake #1 in investing which is selling low and buying high, simply because it makes you ‘feel’ better. You are best served to have a sound financial plan that does not try to predict, but rather is prepared for inevitable short-term price declines, so that you can let your stocks recover while using other sources of cash and/or income to cover near-term needs.

 

Which Door Do You Choose, #1, #2 or #3?


Predicting short term stock price movements is not possible, however you can fairly accurately assess where markets may trade years into the future given historical annual averages. For example, the DOW is currently around 34,000. This means it will likely be trading somewhere between 60,000 and 70,000 10 years from now. These may sound like big numbers, but stocks double approximately every 10 years if they are up around 7% per year (which is below the real historical average of closer to 9%). As such, if stocks increase by 6% - 8% annually on average over the next 10 years (a reasonable assumption), then the DOW will be somewhere in the 60K – 70K range as we enter 2033.


Let’s assume for the purposes of this analysis that stocks exactly double over the next 10 years (go up around 7% per year on average). The question is, for those who are net savers/investors (either through dividend reinvestments, or via adding more to their investments by way of annual retirement plan contributions, etc.), would you rather that the DOW 1) go up exactly 7% per year like clockwork (very little volatility or downside), 2) drop very low, let’s say get cut in half to 17,000, stay there for 9 years, and then rally to 68,000 the final year, or 3) skyrocket to 68,000 tomorrow and stay there for 10 years. In all cases, stocks end up at the same place, the only question is how they got there.


Emotionally you might prefer to have the market race to 68,000 right away – who doesn’t like to see quick gains. Conversely, I am sure that many investors would fret should the market get cut in half. Many would sell, saying to themselves, ‘I’ll never fall for that again – the market is rigged by Wall Street’ or some such thing.


But objectively speaking – which is all that ultimately matters - you are far better off having the market down for as long as possible given reinvestment of dividends, let alone if you are regularly adding to your investment account (contact me directly for a better understanding of how much larger your account would be in 10 years under the scenario where it is down for 9 years and then quadruples the final year to 68,000 as compared to the other 2 possible outcomes). And while my scenarios are clearly the extreme, if you put that mindset into normal market ups and downs along the way to ever higher prices, then you can see that the short-term declines actually work in your favor, not to your detriment.


The market will be where the market will be in 10 years, and if history is any indication, it will be a lot higher than it is today. As such – and given that you have precisely zero control over prices between now and then - what you do have, is a lot of control over your savings rates, expenditures, the quality of your investments, your actions/inactions, etc. You are very well served to ignore said ups and downs, and instead focus on letting your dividends reinvest and being confident that the process works when you avoid big mistakes – like trying to time the market and missing big up periods.