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- Thousands of new investors have poured money into the stock market since it took a nosedive in response to the coronavirus crisis.
- But trying to time the market is a dangerous game, and I don’t recommend it.
- If you’re new to investing, invest for the long term. And remember that pulling your money out of the market too soon could result in short-term capital gains tax.
- SmartAsset’s free tool can find a financial planner to help you take control of your money »
This recent and severe downturn saw the S&P 500 fall 20% in just 16 trading days. It hit the bottom when it clocked in a 34% loss in a total of 24 days.
When the stock market sees a decline of this magnitude, it tends to incite two behavioral reactions from most investors: One, sell in a panic when the market is at distress prices in hopes of “stopping the bleeding.” Or two, look at the pullback as an entry point to buy stocks at a much lower price.
Regardless of how you might have reacted, we’re all sitting here in June with the benefit of hindsight — as well as the benefit of the market having an almost equally speedy recovery, since the S&P came roaring back from March lows and closed out the quarter with gains of over 35%.
If you’re one of the many new investors who only recently entered the market, you need to be careful not to let what could look like a very nice return right now trick you into making silly mistakes with your portfolio in the coming months. As a newer investor, here’s what I suggest you keep in mind.
To perfectly time the market, it’s not enough to get it right one time. You need to successfully do it twice to execute a flawless trade: once when you buy the investment at its lowest point, and again when you sell it at its highest.
The bull market that ended on March 12 ran for over a decade — and many individuals who tried to time the market met their fate along the way. Since 2009, I’ll guess you’ve had friends, family, and neighbors (or heard pundits and so-called market experts) make predictions that the next market crash was just around the corner.
The problem with those predictions? For 11 years, they were all wrong. The last bull market kept going up and up and up — even as the United States had its credit rating downgraded, oil prices collapsed, the cryptocurrency bubble burst, trade wars broke out, Brexit happened, and we faced a different pandemic threat from Ebola.
I know you have heard this a thousand times before, but I have to say it once more: No one has a crystal ball, and I’m pretty sure if they did, it would be shattered into a million pieces out of sheer frustration with trying to time the market.
Those who were fortunate enough to purchase stocks at the bottom of the bear market in March got to enjoy a recent rally of over 35%.
But, if you intend to hold your positions in those investments for less than one year, your good luck can come at a steep cost.
You may see an increase in your overall tax bill should you sell soon and therefore be required to pay short-term capital gains. Short-term gains rates are the same as ordinary income rates and can go as high as 37%.
Holding an investment that realizes a gain for over one year, however, will qualify you for a lower-rate, long-term capital gains tax treatment. These rates can range from 0 to 23.8% (including a 3.8% net investment surtax).
When you invest in the stock market, you want to try to give yourself the longest time horizon possible, which is the amount of time between today and the point at which you want to sell your investment and access the funds.
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Countless studies show that the likelihood of your investment yielding a positive return increases as your time horizon increases. That’s because the market generally increases in value over time (and we’re talking decades here, not just days or weeks). The more time your investment has in the market, the more of an opportunity it has to grow, benefit from compounding returns, and ride out short-term volatility.
Let’s assume that you invested in the S&P 500, and you hold an investment anywhere from one day to one year, your chances of a positive return are approximately 53% to 74%. Should you increase your time horizon and hold that same investment for five, 10, and 20 years, your chances of yielding a positive return increase to 87%, 94%, and 100%.
As much as the idea of a quick win might appeal to you, keep the facts in mind: The odds are statistically stacked against you to get lucky over and over again. It’s highly unlikely that you’ll repeat this level of performance enough times to grow your wealth significantly, so you’re better off sticking with proven strategies to grow your net worth over the long term.
Malik S. Lee, CFP, CAP, APMA, is a financial expert with nearly two decades of experience and is the founder of Felton & Peel Wealth Management.