Investors have been asking themselves, “Should I be investing right now?” since investing in the stock market was a thing.
There are fundamentally two schools of thought on this question:
- It depends on how well you understand the stock market conditions
- Since you can’t predict the market, you should always assume it’s a good time to buy in and hold forever
The first school: Market timing
The first option is roughly what could be considered “market timing.” The idea is that you want to try to predict the future of the market and depending on the results of your predictions, make your investment.
For example, if stock X was $50 but you predicted that in a month it would be $60 then it stands to reason that, yes, you should invest in that stock right now.
Similarly, if you predicted that stock X would be $40 in a month you would not want to invest in that stock right now. And if you already owned that stock and were engaged in the prediction business, you might even consider selling it right now.
The same principle of timing the market applies to the market as a whole e.g. predicting whether we are about to enter a bear market or whether the bull market will continue for another year.
In order to make good predictions, you might read financial news, listen to the advice of experts, investigate the financial fundamentals of companies, research into industry trends, or, *gasp*, read Reddit or Twitter.
Fundamentally, market timing occurs anytime you try to predict the future of the market and try to profit from your knowledge.
Crucially, however, market timing only works if you have an information advantage over your competition. If you heard on the news an expert saying a stock is about to go up and that expert happens to be right, such knowledge will do you no good if other people are able to act on that knowledge faster than you.
And this is where the individual investor is at a severe disadvantage compared to institutional investors. Institutions utilize computer trading to execute millions of trades a second at lightning speed. Institutions have literally cut through mountains to lay fiber optic cables to execute trades milliseconds faster than the competition.
Institutions hire dozens if not hundreds of PhDs to use complex mathematical models to predict the market, absorbing as much market knowledge as possible in order to gain an informational edge. If you’re a market timer, that’s your competition: legions of very intelligent people literally paid to do research and analysis all day long.
But what if even with all that knowledge, it’s just really dang hard for anyone to predict the future?
The second school: What if we can’t predict the future?
Nassim Taleb famously introduced the investing world to the concept of “Black Swans.” These are events that have severe effects on the world, and thus markets, but were unpredicted and beyond the expected. A classic example is 9/11. Or perhaps COVID (even though COVID was predicted by many, few could have guessed in 2019 how 2020 would play out).
In some sense, it is impossible to know ahead of time what the next Black Swan will be. If you knew ahead of time, it wouldn’t be a Black Swan.
These are the unknown unknowns. The “three-body problem” in physics is such that it’s literally impossible to precisely predict the behavior of three bodies of matter interacting with each other in terms of Newtonian mechanics.
If mathematical physics can’t predict the behavior of three balls orbiting each other, what chance do we have of predicting the complexity of billions of humans all interacting in the complex, intricate way that constitutes financial markets?
Thus, the second school of thought forgoes any attempt to try to predict the future of the market and thus time the market.
However, people in the second school have to do something. They can’t just do nothing and not invest at all, because holding pure cash is a losing proposition due to inflation lessening the value of money every year.
Moreover, people in the second school are empiricists insofar as they try to use past data to inform their decisions.
And if you zoom out and look at the aggregate, historical record of the stock market over the past hundred years the only consistent trendline is that the stock market (at least the American one) always goes up if you wait long enough.
If you had put 50,000 in an index fund back in 1980 and completely left it alone, you would be very rich right now. But this would entail that you resisted the urge to sell your position during every subsequent stock market crash.
But if you managed to hold onto your position, you’d be a millionaire many times over as of 2021. In other words, the most important factor in stock market success according to the second school is more emotional and psychological than knowledge-based.
You simply throw as much money as possible into a diverse set of low cost, low fee, low turnover index funds as often as possible and never ever sell (until you’re ready for retirement, that is).
If you do that, you have as sure of a shot of becoming rich as any other investing strategy. Will it give you the highest rate of return? No.
Is it 100% guaranteed? No. Of course not. An asteroid could destroy human civilization tomorrow and your investments in the stock market would be pointless when 99% of humanity is wiped out and driven back to the stone age.
Is it the surest route to stock market success based on the historical record? Absolutely.
This “buy and hold” school of thought requires supreme patience and an ability to ignore hype, trends, and the emotional fortitude to not panic when the market crashes.
If your 401k loses 30% of its value and you panic and sell, you are at great risk of not making this strategy work. You absolutely must have the fortitude to be in it for the long haul and ride out all the inevitable booms and busts.
So, should I be investing right now?
If you try to time the market you stand to make a much higher rate of return. But the research shows very few people are successful at such a game and the winners are most likely just very lucky.
If you take a million people and have them predict a coin flip and have successful predictors move onto the next round to flip again, you will eventually select down to a single very lucky individual who might come to assume they are highly skilled at predicting coin flips.
Research indicates successful mutual fund managers are “skilled” in exactly the same way as “skilled” coin flipper.
So to answer the question, if you are a market timer, then whether or not you should invest in the stock market depends on your belief in your own ability to predict the market.
But if you’re in the second camp, then the answer is that you should always invest in the stock market, whether it’s up or down, so long as you invest in diversified index funds and are prepared to hold onto that position for a long, long time.