It’s crazy how three months can change things.
Last fall, my inbox was overflowing with messages from nervous, even panicked, investors.
After an upward start to the year, the financial markets were sinking a little further each day. Inflation was back. And experts predicted a sharp fall to come.
Three months later, where are we?
Inflation is falling. Markets rose 12% in Canada and 18% in the United States. And the end of the world still hasn’t happened.
So everyone is happy? No ! Now, it is the markets at record highs that are causing questions.
“I am 21 years old, I am a student, and I opened an online brokerage account in order to invest $10,000 for 10 or 15 years,” wrote me a reader who was decidedly less lost than I was at his age.
This reader writes that they want to buy shares of an exchange-traded fund (ETF) with asset allocation “like VEQT or XEQT”. He wonders whether he should buy right away or wait until the value of the fund decreases.
“If I start my long-term investment 10% lower, that could still make a big difference, right? »
Another reader has a similar question: “Is there an optimal time to invest?” Should we hoard our money and wait for a drop before buying? Where should we buy at a fixed interval each payday? »
I like these questions, because all investors ask themselves one day or another. It’s human nature to want to maximize your chances of making a profit.
The problem is that in investing, human nature generally works to make us poorer.
The best time to invest
First, it’s true that the markets are at high levels.
The S&P 500, the index that represents the 500 largest companies in the United States and which has captured the hearts of millions of investors for a decade, recently closed at 4,927 points, a record. An investment in the S&P 500 is up 26% over the past year, when including dividend reinvestment. For those watching at home, that’s 22% above inflation over this period.
In Canada, the S&P/TSX index, which represents the country’s stock market, recently closed at 21,244 points. This is less than the level of 22,000 points recorded in 2022. But we are 4% from a peak.
Next, should these high levels prevent us from investing?
Benjamin Felix, head of research at PWL Capital, studied the phenomenon in eight developed markets, including the United States and Canada, with data spanning from 1970 to 2020. His analysis1 showed that waiting for a 10% or 20% fall from a peak before investing produced lower returns on average in the majority of 10-year periods studied.
As for the idea of investing a fixed amount at regular intervals rather than investing all at once, research also shows that it generally pays off less.
Mr. Felix calculated that investing a sum at once gave better returns after 10 years2 in 65% of cases only buy at regular intervals.
Even in bad historical times for stocks, investing a sum at once was better in just over 50% of cases than investing at regular intervals.
In short, the best time to invest is when you have the money to do so. “Wait for falls” may seem logical. But this is not a predictable way to improve returns.
That said, we will often invest at regular intervals simply because we make purchases from our salary – we cannot do otherwise. From a behavioral point of view, this method can also help us minimize regrets if we buy everything just before a fall. For example, you can divide the amount to be invested into five, and invest part of it on the first day of each month.
Is this optimal? Statistically, no. But if it can help us sleep well, this technique will have accomplished its job.
Also, it’s counterintuitive, but the fact that we have just had a bullish year doesn’t tell us anything about what the markets have in store for us for the year ahead.
Financial author Ben Carlson calculated3 that the S&P 500 was up nearly three out of four years since 1926. After a year of decline? The index was up nearly three years out of four. And after a year of increase? The index was up…nearly three years out of four.
“Trying to predict the trajectory of the stock market based on what it has done over the past year is a lot more difficult than you might think,” he says.
Synchronize the markets
The problem with “waiting for the dips” before investing in a diversified portfolio is that you never know when, or even if, dips will occur.
I started investing seriously in 2012. At the time, the Dow Jones index, which measures the performance of 30 large American companies, had just passed the 12,000 point mark. It was huge: a few years earlier, the Dow Jones was trading below 9,000 points.
What would have happened if I had decided to wait for the sales?
Twelve years later, I would still be waiting.
This is because the Dow Jones has no longer revisited 12,000 points. Today it is at 38,000 points.
Of course, the market could have quickly fallen to 9000, and I would have been disappointed to have bought when it was at a peak. All this was impossible to predict. This is the lesson to be learned.
On a chart, a drop looks like a great buying time. In real life, when markets fall, it’s often for good reason. And this good reason is often terrifying.
Suddenly, many investors decide to postpone their investment plans… Some even decide to sell, thus crystallizing their losses.
“You cannot exercise control over the market. You have to try to engage autopilot so that your emotions don’t get the better of you,” wrote financial author Burton Malkiel.
Bad investing behavior is part of human nature: it never changes.
Our challenge is to use knowledge to better manage our behavior. That’s all we control anyway.