Sitting on the sidelines?


You may want to re-think that.


The biggest risk of investing is not being in the market when it goes down but being out of the market when it goes up.

Why do investors sell? One reason is they think they can control risk by timing the market. The thinking goes like this - "If I can sell my investments at the top, I can avoid losing money."

In other words, trying to time the market is a risk-reduction strategy for many investors. The market seems high, so they better pull money out of the market.

Sounds good, right? Unfortunately, the reality is that you're never going to successfully time market tops and bottoms. You might get lucky a few times. But the one time you're wrong, you'll undo all the times you were right.

If you take nothing else away from this tip, take this: The biggest risk of investing is not being in the market when it goes down but being out of the market when it goes up.

Markets move in bursts. In 1998, for example, the Dow Jones Industrial Average moved from 7,539 to nearly 9,400, a 24 percent move, in less than 3 months. Many investors missed this move because they got out of the market when it dropped in August and September.

The following example comes from Investor's Business Daily: If you had invested in the S&P 500 at the end of 1981, and reinvested earnings and dividends until year-end 1998, you would have earned a 21 percent average annual return. If you attempted to time the market and missed just ten best trading days during that seventeen year period, your return would have fallen to 16 percent per year.

Losing 5 percent per year doesn't sound like much.

It's huge.

A $10,000 investment earning 21 percent per year (compounded monthly) for 17 years grows to $344,366.

A $10,000 investment earning 16 percent per year for 17 years grows to $149,099. Your penalty for missing the best 10 trading days during that 17-year period? $195,266.

And if you were really aggressive in timing the market and missed the thirty best market days in that 17-year period, your average annual return drops to just 9 percent.

In order to maximize the power of time and compounding, you have to be in the market when these bursts occur. Every time you pull money out of the market, you run the risk of missing those important rallies that create seven-figure portfolios. Don't worry about reducing risk by marketing timing. The proper way to reduce risk is by lengthening your holding period and diversifying across various types of stocks.

Besides, the payoff for perfect market timing, when you consider the risks, is rather skimpy.

Let's say you invested $10,000 every year from 1988 to 1997 in the S&P 500 Index. And let's assume you are the world's worst market timer. You invested that $10,000 every year at the exact market peak in the S&P 500.

At the end of ten years, how much money would you have? Your $100,000 investment ($10,000 times ten years) would have accumulated to a not-too-shabby value of $246,476. So even with lousy market timing, you more than doubled your money.

What would have been the payoff had you invested the $10,000 at the exact low every year for ten years instead of the exact peak? Surprisingly, you would have added only $60,000 to your take, or an additional 24 percent.

No $60,000 is not chump change. Still, when you consider the huge risks you incur to attempt perfect market timing for ten years, and the even larger odds you face against being successful, a 24 percent payoff for your efforts seems hardly worth the risks.

And riding through a market downturn isn't the worse thing in the world. For starters, market declines provide opportunities to buy favored stocks at bargain prices.

Second, history has shown that markets usually rebound reasonably quickly from major declines. During the twentieth century, the stock market rose in roughly three out of every four years. Furthermore, following every one of the major market declines in the last forty years, the stock market regained its previous peak in an average thirteen months and went on to new highs.

Of course, there have been times when markets declined and didn't recover for years. However, the percentages say that you probably won't have to wait more than a couple of years for markets to regain their lost ground. And if you buy during the down period, you amplify your gains when the markets recover.

The upshot of all this is that you can do just fine riding through market downturns and buying at market peaks. The trick is that you have to be committed to a long-term investment strategy.

Conversely, you can get yourself into a world of trouble in the name of risk reduction by trying to time the markets.

More than 70 percent of everyday millionaires say they don't time the market. In fact, more than 70 percent of our millionaires don't invest differently whether it's a "bull" or "bear" market. They buy and hold, buy and hold, and leave the timing to the chumps.

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