But what if, alongside regular investing, we build up extra cash for when the market does finally fall? Today we’ll consider this approach, and I’ll share my thoughts – which may even surprise you.
The stockpile approach
I’ve come across many people who, like myself, are regular investors. They keep it simple with low-cost diversified funds, and focus on the long term. Many would even consider themselves dividend investors.
But they have another part to their plan. Alongside regular buying, they also build up extra savings slowly over time, which they don’t invest. Instead, the idea is that when the next downturn finally hits, they can use this excess cash to take full advantage of lower share prices.
And that actually makes sense. After all, who wants to buy shares when they’re expensive? Wouldn’t you rather buy the same investments at a 5% dividend yield than a 3% dividend yield? I would!
As far as market-timing strategies go, this one is quite compelling. That’s because it’s not an all-or-nothing bet. It includes good old dollar-cost averaging too. You could say it combines the best of both worlds.
So let’s explore this road a little more, and see how it might play out.
Can you time the market?
Firstly, if we’re going to time the market, we’ll need a plan. Surely you weren’t just going to wing it? Despite how sexy and seductive it sounds to our brains, we must admit we have no real intuition or insight into future market moves.
Oh, you stay up to date on all the news, politics and even Trump’s twitter account, so you can figure out what’s coming next? That’s great. Because you’re the only one doing that!
Well, apart from the other 64.2 million twitter followers he has, and the 24-hour news networks streaming important info to another couple billion people that is.
Anyway, back to the plan!
Let’s say you’re building up this little pile of cash, in addition to your regular investing. When the downturn hits, then you’ll pounce.
But how do you decide when to put the money into the market? When the market falls 20%? 30%? What about 50%? How do you choose one?
Maybe you decide if the market drops by 40%, you’ll dump those savings in. But then what if it falls only 35%? Pick any percentage and the decision is still the same. Choosing a precise target and using this all-at-once approach would be very difficult.
Maybe you decide you’ll buy at intervals. So when the market falls 10%, you’ll put in a bit. When the market falls 20%, a little more. Then some more after a 30% drop. And finally, when the market’s down 40%, maybe you’ll be all-in.
Okay, we’ll think this through together. Because if we’re going to do this, we’ve gotta plan our actions in advance, or it’s probably not going to work.
Let’s say we’ve got our meaty cash cushion sitting there waiting. You decide to put money in at even increments – after each 10% fall, up to a 40% fall, at which stage you’re all in. This approach is likely to be a bit more effective than the all-at-once approach.
Now let’s say over a period of 6 months, the market falls 12%. Things are looking good, so you tip your first lump into the market. It feels good. You’ve got yourself a bargain! “I knew this was a good idea!”
The market then falls a bit more, it’s now down around 18%. Do you tip more in? Well, your rules say no, you have to wait. But part of you thinks this might be the best chance you get. After all, 50% crashes are actually pretty rare events.
Let’s say you wait. The market falls through your 20% threshold and is now down around 29%. You invest extra at 20%, but now you’re not sure again. A 29% fall is pretty damn close to 30% – is that close enough? Do you break your own rule? What if it was 27%?
Maybe the market starts going back up. You start wondering, is this it? Have you missed your shot?
Now you’re carrying this extra cash and you didn’t even get to invest much. If you invest now, you can still buy cheaper than before the falls. What do you do? Hmm, decisions.
If the market falls 20%, how do you know it won’t fall another 20%? Likewise, if it falls 40%, couldn’t it easily fall further?
On the other hand, maybe the market falls 15%, recovers, and then continues rising for another ten years. All are possibilities and by playing this game, we can’t help but try and figure out which one it is! But there’s no rule for how far the market will or won’t fall.
Instead of this, maybe things get even worse. The market falls further, more than 30%. So of course, you follow your plan and tip more funds in. The headlines and news stories are feeding the negativity more and the market falls heavily, it’s now down almost 40%.
You start getting a little worried as it feels scarier than you imagined. There is talk of large financial institutions going under and political tensions are worsening around the globe. Unemployment rises, people are losing their homes, and some of your friends lose their jobs and are struggling to find work.
This isn’t quite the fun scenario you imagined.
Everything around you convinces you there’s worse times ahead, and your own job may be less certain than you thought. So you decide to keep your cash pile for now. You’ll reassess things in a few months.
You might scoff at this scenario. But these things are worth thinking about. You’ll have to make these decisions in real time. And it won’t be easy. It’ll be scary. It’s likely you’ll want to wait for things to clear a little before putting more money into the market.
Be careful what you wish for
Related to the above, maybe you get the downturn you imagine. The sheer amount of negativity around will be overwhelming.
So the natural approach is to wait for just a little bit of positive news, some ‘green shoots’, before tipping the last of your funds into the market. But remember this…
The best time to buy will very likely be the scariest time to buy. When everything inside you screams don’t do it, and seemingly nobody wants to own shares. When the economy is in the shitter and the market falls further every week.
By the way, the dust never settles. Consider this…
After the GFC, there was non-stop talk of the global economy not recovering, and instead falling into a deeper recession. It was likened to the Great Depression all over again.
Then for years the European debt crisis was going to drag the global economy backwards. After that, every year there have been ongoing fears of the Chinese economy slowing, dragging Australia down with it.
Then it was Brexit (still ongoing). Then Trump as President (still ongoing). Then Aussie housing was going to ‘collapse’ – isn’t it always? Now it’s the trade wars.
Waiting for the dust to settle? Yeah, good luck with that! Quite clearly, this shit never ends!
As I said during the Playing with FIRE chat session, every single year there are recession predictions. And if you listen, you will never invest. Since the GFC, you would’ve missed out on very solid returns, from basically every asset class – local shares, international shares, property etc.
The human element
The part often missed in these thought experiments, is the human element. That is, the feelings and emotions behind the person making the investment decisions.
Sure, it sounds ridiculously easy to invest when the market falls heavily. But in real life, we often get in our own way. We get worried about our portfolio falling further. About potential job loss for ourselves, friends and family.
Maybe efforts to stimulate the economy won’t work. Maybe we’ll be stuck in a stagnant economy for an extended period.
Maybe Aussie companies’ earnings will get hammered and there’ll be a big decline in dividends. Now those big dividend yields on offer don’t look so good, because the dividends themselves may be cut. The uncertainty of all this causes fear and inaction.
By the way, I can’t say I’m immune to this either. I’m young enough to have never lived through a recession and never experienced a sharemarket crash. As an earlier property investor, I didn’t start investing in shares until 2015. So while I have faith in my ability to stay the course and maintain a long term focus during tough times, that remains to be seen!
As we’ve discovered, the all-at-once approach, and the interval approach could both prove difficult to follow. But building up lots of extra cash has another complication.
The longer we wait, and the more cash we’re holding, the bigger the decision feels. This creates increasing amounts of anxiety to get the timing right.
That can cause us to wait longer for a larger fall, because we’ve got more emotion (and dollars) invested in the outcome. We’ve made the choice and we want to make sure it was worthwhile. We want it to be a success. Because if it’s not, then we’ll be left with the uncomfortable truth that perhaps we were wrong to time the market.
So in a sick way, we won’t be satisfied with a 20% fall. We want a real shitstorm to occur to justify our approach. Otherwise it just won’t feel worth it.
As humans we love being right. It’s like an intellectual orgasm, and it gives us something to brag about. Can you see how it’s inevitable that our emotions will be wrapped up in the outcome?
Consider the situation where, after a small 15% drop, the market recovers and steadily rises to new highs. As time goes on, our market-timer has a hard time knowing what to do. He was convinced a big downturn was coming. He could feel it in his bones. And the well-meaning experts confirmed his view. But it doesn’t eventuate.
This is the seduction of market-timing. It feels cautious. It feels prudent. But numbers aside, the difficulty in managing emotions and getting it right is astounding.
In contrast, consider a blissfully ignorant investor, who continues to pour money into the market (seemingly down the drain when the market is falling).
She ignores the portfolio movements, continues receiving larger and larger dividends, while the market-timer’s cash sits stagnant in a crusty old bank account collecting dust, with the rats of tax and inflation gnawing away at its value with every year that passes.
The market-timer grows ever-more resentful of these seemingly idiotic investors, and the emotion of being right festers on itself. But he quietly wonders, maybe this isn’t such a good idea after all?
Believe it or not, I can actually get on board with the market-timing idea that I’ve laid out (well sort of), which I’ll talk about soon. But first, some perspective.
How long is long term?
When the sharemarket has had a good run, it’s pretty easy to believe there’ll be a better time to buy, other than right now.
If I catch myself getting too caught up in these thoughts, here’s what I do. I come back to the reason for investing. To grow our wealth and provide an increasing income stream over time. That means over our lifetimes.
So I’m reminded of the purpose of this money, and the many decades it will be invested for. Essentially for the rest of my life. Given I’m 30 now, that’s going to be at least 70 years (yes I’m an optimist).
And with a bit of planning, this money could remain invested for much longer, inside a charitable trust, with the income distributed to charities each year. So it’s a very long time-frame indeed!
Now let’s take a look at what the sharemarket might do over that time.
Putting it in perspective
With our market having a dividend yield of 4%, and a strongly growing population, we could perhaps expect company earnings to grow by around 3-4% per annum over the long term. So we could also expect share prices, and in turn the index, to grow by the same rate over the long term.
As I write this, the ASX 200 is sitting at a value of 6,650 points. Here’s my rough estimates of what the future value of the Aussie sharemarket could be with a growth rate of 3-4%. These numbers are pulled from my backside (of course) and rounded for simplicity.
2019: ASX 200 – 6,650. (present day 12/09/2019)
2030: ASX 200 – 10,000. (requires 3.78% growth per annum)
2040: ASX 200 – 15,000. (requires 3.95% growth per annum)
2050: ASX 200 – 20,000. (requires 3.62% growth per annum)
2060: ASX 200 – 30,000. (requires 3.74% growth per annum)
2070: ASX 200 – 50,000. (requires 4.03% growth per annum)
2080: ASX 200 – 70,000. (requires 3.93% growth per annum)
2090: ASX 200 – 100,000. (requires 3.89% growth per annum)
ASX 100,000, baby! I’ll be there for the party! Hell, I’ll be 101 years old, and I might break a hip dancing, but I’ll be there!
Maybe the market even gets there a little early, for my 100th birthday. Come on Australia, you can do it!
But in all seriousness, this is basic compound interest at work here. Nothing all that far-fetched, except maybe me dancing.
Will it happen exactly like this? Of course not. So in this sense, the scenario is laughable. But it’s also very valuable, because it helps put today’s investment decisions in perspective.
These numbers force me to consider the time-frame really involved and realise the utter waste of time and effort it is to focus on getting the short-term timing right. And of course, this completely ignores the dividends and franking credits earned along the way.
If you’re buying shares at 6,600 before they fall to 5,000…. on their way to 50,000 or 100,000, does it really matter?
My view is no. And you’ll only know in hindsight anyway. By the way, feel free to play this game yourself, using a simple compound growth calculator.
Why market timing is likely to fail
By hoarding cash until the next downturn, the results probably won’t be as good as the ignorant investor who keeps buying as much as she can.
Because then we’d be betting against history. Effectively, we’d be betting against progress.
The market rewards investors over the long term, despite the setbacks from time to time. So our job is to roll with the ups and downs and not to expect a smooth ride. The downs will hurt, but there’ll be far more ups than downs!
The Australian sharemarket has had positive total returns 4 out of every 5 years. You can see the year-by-year breakdown since 1900 here. In fact, the most common return (by far) for a given year, is between +10% and +20%. That’s tough odds to go up against.
And if that’s not enough, then this blog post runs the numbers: ‘Even God Couldn’t Beat Dollar-Cost Averaging’, by Nick Maggiulli from ‘Of Dollars and Data’. Nick sums it up below…
“Buy the Dip, even with perfect information, typically underperforms DCA. So if you attempt to build up cash and buy at the next bottom, you will likely be worse off than if you had bought every month. Why? Because while you wait for the next dip, the market is likely to keep rising and leave you behind.”
I’m going to throw this out there. We’re all market timers to a certain degree.
Remember, someone who is blindly investing regularly (dollar-cost averaging) is already timing the market without even knowing it! Here’s why…
You’re saving money and buying shares every month. When the market goes up, your money buys fewer shares. When the market falls, your money stretches further and buys more shares.
So if the market falls over a multi-year period, you’re guaranteed to scoop up larger quantities of shares every single month than you normally would. As you can imagine, this is fantastic for building a portfolio, because you’ll do more of your buying when prices are lower.
All without thinking about it. All without even knowing what’s going on. You’re timing the market wonderfully with zero effort!
So regular investors should celebrate. With dollar-cost averaging you get the benefits of market-timing without the mental pretzel of forecasting what comes next, without listening to fortune-teller shenanigans, and without the anxiety and emotional overload of trying to pick when to dump your money in.
When it’s okay…
Obviously, I’m not in favour of full-blown market timing, where you’re all-in or all-out. But here’s where I can get on board.
If regular investing, plus having extra cash for market dips is what you feel most comfortable with, then go for it. Seriously. It’s probably not going to make or break your end result. You’ll still become financially independent.
We each have our own unique personality traits, risk tolerance and comfort zones and there’s just no approach that fits everyone.
Having this mental comforter (and ability to buy more shares) might be what helps you stay the course during a scary time in the market. And if it does, then it’ll prove to be totally worth it.
As long as you’re investing in sensible low-cost diversified funds and not buying tiny speculative stocks like lottery tickets, then you’ll still do pretty well.
Just be aware that the extra cash is likely to be a drag on returns over time. And it’ll probably be harder than you expect to put that money in when stocks are falling, as you’ll agonise over whether it’s the right time or not.
But if that’s okay with you, then it’s fine by me. For most of us though, it comes back to the simple things.
Focus on what you can control
Don’t spend a minute of your energy and mental space worrying about things you can’t control. Easier said than done, I know. But a good thing to remind ourselves, nonetheless!
We can’t control the market. But we do have power over plenty of other things. Like our lifestyle. Our savings rate. And what we focus on.
Part of that focus should be extending our time horizon. It doesn’t matter what happens in the next 6 months. What really matters is the next 50+ years. Because you’re buying these investments for their ability to provide an income stream for the rest of your life. Short-term share prices are irrelevant.
I’ll finish with a short summary of our personal approach to investing in shares.
Our goal is to increase our ownership of a large group of productive businesses, via index funds and listed investment companies, which will provide an increasing flow of dividends for the rest of our lives.
By waiting for a ‘better time’ to invest, we’re not progressing. We’re not working in line with our goal of ‘increasing our ownership’.
But as we keep buying shares, our ownership stake increases. And with it, our share of the earnings and dividends from those underlying companies. Every single time we buy, our annual dividend income goes up, in line with our goal.
And the best part is, we can use this growing snowball of dividend income to buy even more shares, when the market does eventually fall.
What are your thoughts on timing the market? Let me know in the comments…