Our company gained two new clients towards the end of 2007 who had both received a large influx of money by selling their business. Let’s call one client Smith and the other Jones. We gave them both the same advice: invest the money over the next 12 months at predetermined intervals. Smith followed this advice throughout the market’s steep fall in 2008. It was very difficult because with every tranche of investment, the economy and the markets were insanely volatile, and fear gripped us all. Jones, on the other hand, invested a slice in early 2008, then only invested the rest in 2011, when it appeared the economy was out of the woods. Who is doing better financially? Black-smith. Although she invested just before and during the market’s worst downturn since the Great Depression, her portfolio has rebounded well. Jones’ portfolio avoided much of the decline in 2008 and early 2009, but missed the strong returns of 2009 and 2010 after the market bottomed out.
It may come as a surprise that Smith, who invested just before and during a bear market, did better than Jones, who waited until the coast cleared. But history has shown that investing before a bear market (or staying invested) isn’t as bad as you might think and sometimes turns out to be great. Unless you correctly call the ups and downs of the market, which beyond being lucky is nearly impossible, you are generally better off investing cash in a diversified and disciplined manner than trying to time the markets.
It might sound counterintuitive, but consider the following charts. Each assumes an investor starts with $ 20 million in cash and invests in a diversified portfolio (around 70% / 30% stocks / bonds), which is rebalanced quarterly. The $ 20 million in cash is invested in a lump sum on January 1 of each of the years shown.
The first chart shows that investing on January 1, 1998 (the green line) – about two and a quarter years before the market peaked during the dot-com bubble – produced the best long-term returns. The second best result came from investing on January 1, 1999 (dark blue line), only a year and a quarter before the market peak! In all scenarios, the $ 20 million more than doubled as of September 30, 2018. Waiting for the stock market to roughly bottom in January 2003 came in third.
The following graph illustrates the same exercise over a shorter period around the 2008 financial crisis.
If you invested money in the market on January 1, 2009, three months before the market bottomed out, you did better. But investing on January 1, 2006, less than two years from the top of the market, gave the second best result. Waiting for a “clear signal” and delaying until 2011 gave the worst result (as our client Jones experienced).
A 2012 study by JP Morgan * reinforces this point by simulating an investor “waiting for a sharp turnaround in the economic cycle before adopting normal investment positions”. The study looked at two different strategies:
One: stay fully invested in the good times as well as in the bad times; Where
Two: invest only when the “coast is clear”.
The report defines the coast being clear as when the stock market valuation is reasonable, unemployment is low or falling, the economy is expanding, and inflation is below 4% or falling. If the economy meets all these criteria, then the Coast-is-clear portfolio is invested in the stock market; otherwise, the wallet is moved to cash.
How did the two portfolios go? While the Coast-is-clear portfolio was less volatile, it sacrificed a lot of return. From 1948 to 2011, the “always invested” portfolio beat the Coast-is-clear portfolio almost three times and from 1980 to 2011 more than twice.
The lesson from both charts and the JP Morgan study is that investing before a bear market is likely to turn out well as long as you stick to your investing strategy and periodically rebalance your portfolio accordingly. In addition, the above simulations do not include portfolio withdrawals; it’s a good idea to have a safety margin in cash if you might need to spend out of your wallet.
There is no ringing bell to signal the best time to invest, and waiting for the coast to clear is a poor investment strategy.