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Why Market Timing Can Destroy Your Retirement Savings Thumbnail

Why Market Timing Can Destroy Your Retirement Savings

Investing

During sustained periods of stock market upswings, it can be easy to forget that investing in stocks does in fact involve risk and can sometimes take you on a rollover coaster of emotions.  Its actually very normal for the for the stock market to hit some speed bumps.    Experts say a 10% correction typically occurs every 1 to 2 years. 

Given this type of history, its completely logical to expect these types of stock market corrections on a fairly regular basis.  Unfortunately, when it comes to investing, our brains are not wired to think rationally.   One of the most costly investing mistakes I see over and over again is when people try to time the markets thinking they can give their returns an extra boost.  Market timing means they are jumping out of the market when times get tough and waiting too long to get back in.  Take a look at the chart below which reflects how much potential long-term growth you can miss out on by not being invested on just the 5 best market days.  The more days you miss, the more money you lose.  

What makes market timing so difficult is that there are two parts to the equation.  You don't just have to correctly time when to jump out of the market which is hard enough as it is, you also have to correctly time when to jump back in.  According to a study by JP Morgan Asset Management, during a time period from January 4th, 1999 through December 31, 2018, six of the ten best days occurred within two weeks of the ten worst days.  This means market timers are most likely out of the market at times when it is performing its best.  

It's important to recognize that it's perfectly normal to feel a bit of anxiety during volatile markets, but there are some ways to reduce it.   If you are making regular contributions to your retirement accounts, here is one trick I used myself when markets were crashing during the Great Recession.  Don't think about market corrections from the perspective that you are losing money, think of them from the perspective that you are actually saving money by being able to purchase investments that are now on sale.  Let's say you are going to walk into a store knowing that no matter the prices, you have to make a purchase for something you need.  Would you rather see numerous signs advertising price increases or signs promoting price drops on every item?

The same scenario applies to your 401(k) or 403(b) contributions.   A lot of you are probably enrolled in a plan that automatically takes money out of your paychecks to purchase investments.   It happens on schedule every time without regard to what the prices of those investments are on that given day.  A correction is an opportunity to buy on sale.  And if you have years to go before you ever actually need to use the money for retirement, you can take solace in the fact that as long as you keep your emotions in check and stay invested for the long haul, short term drops in the balance of your retirement account are only temporary.   

Of course if you are approaching or already in retirement, it's always important to make sure the amount of risk you have in your retirement accounts lines up with when and how you need to use those funds.   This is especially true because you have less time to recover from corrections.  Being forced to withdraw money from a retirement account just after it has already lost a lot of market value is going to hurt your portfolio's ability to last you throughout retirement.