Long Term Passive Investment Wins Over Market Timing

As any investor from China to America with any exposure to equities learned last year, stock market fluctuations can wipe out half of your nest egg or more in the blink of an eye. While many financial advisors drew the ire of their customers due to reassurances and advice to “stay the course” or “keep a long term perspective”, within a few years, they may be the ones who will have the last laugh.

Capitulation Hurts

I can’t tell you how many personal acquaintances and readers of my blogs have commented on how they were completely done with stocks over the past few weeks – they liquidated their investment accounts completely and went into cash, or worse for some of them, into gold. This is the proverbial “market capitulation” which is generally the very bottom when enough investors throw their hands up in desperation and give up, such that the values to be had in the market are too alluring for money on the sideline to ignore. Those who went into cash are now earning 1-2%, which will rapidly lose value to the significant inflationary environment that will come as the economy recovers (as unemployment declines, the Fed will have to raise the Fed Funds target rate to stave off inflation…and don’t forget, they’ve been printing money like there’s no tomorrow). Those who went into gold may have been hit with a double whammy. Not only did they sell at the bottom of the equities calamity, but now, gold is off its $1000 peak and may yet decline further. In effect, they have picked the absolute worst time to execute both strategies. What is especially painful though is that they just missed a 20% runup in US stocks in 2 weeks by trying to time the market! For every buyer on March 9 (the bottom), there was also a seller. So, you have sellers that lost 50% on the way down from last year’s peak, then, the missed a 20% runup, whereas people with a long term perspective who were dollar-cost-averaging in are looking at a much less painful picture right now.

Rapid Market Recovery

As history has shown, a small number of up days per year accounts for the majority of aggregate market returns in a given year. Even more dramatic though, is the rapid recovery from the market bottom that generally occurs during a recession. Market rallies precede an economic recovery – markets are very efficient in predicting future economic events. Take a look at this candlestick chart over the past 2 weeks. The green bars represent up days and the red represent down days. Some of these up days were in the 4-7% up range.


What Does It All Mean?

In the long run, over spans of 10, 20 years, or more, it has been proven time and time again that retail investors (and about 90% of the time, professional money managers as well) would have performed much better if they had simply left their investments in a diversified portfolio that was formulated to suit their individual risk tolerance and time horizon, rather than trying to time market tops and bottoms. If the best fund managers in the world (and Warren Buffet) can’t time the market, it would be naïve to assume that you and I can. Now, trading to exploit near term market inefficiencies and hedging strategies is something different. For investors who employ momentum investing, exploitation of arbitrage opportunities, utilization of stock options for income, etc., there are opportunities to capitalize on the exact phenomena I described above – fear and capitulation. But, I keep my retirement accounts and trading accounts separate and I have a realistic, pragmatic approach to both, with very different strategies. While I’ve been able to turn some good trades in the recent market tumult and opportunities still abound, I haven’t altered my long term approach to my retirement accounts and at the current levels, I’m benefitting from dollar-cost-averaging into a 15-30 year time horizon at depressed prices.

Most of the people reading this article are for the most part, saving for retirement and college in IRAs, 401Ks and 529 plans. Clearly, with a long term perspective, these accounts would be much better off if you “set it and forget it” and only rebalance occasionally if allocations move out of whack over time. But remember, don’t try and time the market in general or you may well sell at the bottom and buy at the top!

About Darwin’s Finance: Financial Evolution tackles both money saving hacks and investing/trading strategies. For more on topics like reader-generated reviews of the best refinance deals out there to alternative investment strategies, subscribe to his feed.

26 thoughts on “Long Term Passive Investment Wins Over Market Timing”

  1. If you look at the last 13 years of US stock market, taking into account inflation, anyone who bought and held for 13 years have lost (diversified of s&p not individual stocks of course)

    So if you remove dividends (often less then price of inflation) you would have been better off in cash, or funding your own venture

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    1. Trader Mom says:

      I agree with you. Buy and hold is not for me. I am both a swing and day trader. I am doing way better than my husband’s 401k which is managed by a well known company. Timing is everything for me.

      Trader Mom’s last blog post: 10 Trading Sins

  2. anyone that has has a passive investment strategy has been raped. Have you not seen the market tank. A person who lost 50% of their portfolio has to watch a bounce back of 100% just to break even again.

    Passive investing is the worst strategy. Its like having a company and just letting your employees do whatever they want while you sit at home. Investing requires full participation and with the markets moving the way they are, you don’t need to “time” the market.

    Those that want to invest on a 10-15yr strategy with a dollar cost strategy can keep throwing in money. I have been using stop losses to get hell out when indicators point to declines and am up yearly and doing fine.

    ..to each their own I guess.

    [email protected]’s last blog post: Back on Nortel!

    1. Trader Mom says:

      I second Aman’s comment. I am a full time trader, both a day trader and swing trader. My swing positions normally last 3-7 days. I short the market as comfortably as going long. For short term traders like me, timing is everything.

      1. Thank You!

        Timing is everything indeed!

        [email protected]’s last blog post: Back on Nortel!

  3. Kyle says:

    Aman, I have been using a completely passive strategy and am up SIGNIFICANTLY over the past decade, even taking into account the last year’s losses. Passive investing is doing very well in the current environment from my perspective. The S&P 500 is neither diversified nor passive, so that’s not the proper benchmark to use when evaluating passive investment performance. I’ve diversified globally against many different asset classes, not just stocks and bonds.

    Kyle’s last blog post: AIG Bonuses: Who Cares?

  4. Well, it’s easy now to go back and cherry pick the absolute worst period in recent history and postulate that that now proves or disproves a hypothesis, but historically, (and now), the evidence suggests that individual retail investors are horrific market timers. Even Warren Buffet got it wrong!

    Trading is one thing, which I’ve done for everything from leveraged financial ETFs, genearting income from selling option, to Shorting Treasuries, and these have worked out great; but that’s an entirely different strategy than shifting an entire nest egg with a 20+ year time horizon in and out of stocks. For those who tried to do that a few weeks back, they lost 50% on the way down and then just missed a 20% up move. You simply shouldn’t be 100% cash in a retirement account unless you can actually predict the future, which we know nobody can.

    Tx for the comments; I agree with stop-loss orders in the trading account, just saved me big time on my short treasuries move following the Fed’s surprise announcement.

    Darwin’s Finance’s last blog post: How to Profit from Employee Stock Options Regardless of Share Performance

  5. Paul B says:

    The thing thatalways gets me about “bounce back” is that what happens if you’ve bought into a companty that goes tits up? The number of people I know (yes personally, in the real world) that invested heavily (on top of existing portfolios) November last year when stocks “couldn’t get any lower” in companies that have either been a) Made insolvent b) nationalised isn’t funny. Hundreds of thousands of pounds written of with NO CHANCE of making that money back.

    Not everybody makes money with stocks, that’s just not the way the world works – it’s gambling – there have to be losers.

    You’d be much better investing that money in yourself.

    Paul B’s last blog post: How To Fix The WordPress “Schedule Missed” Problem

  6. Duncan Lamb says:

    Darwin, have you done the math on your reccommendation? You’re spouting off what the financial planning community has been saying for decades – which is wrong. Here’s the truth – treasuries have outperformed “dollar cost averaging” investing in the stock market for the last 40 years+. Here’s a link to the numbers, and a spreadsheet with all of the info.


    It’s shocking really, to think that nearly everyone under 45 would have done better to stay in cash over that whole time.

  7. fas says:

    Quite an enlightening post there. I think one needs to be careful in the market, which can go southwards soon.

    fas’s last blog post: Online Buying Tips

  8. dg says:

    Most important (and expensive) lesson I ever learned about the stock market: never own a stock “naked”. When you purchase a stock decide how much you are willing to lose on it, then put in automatic sell order on that loss price. This forces you to make a non-emotional decision ahead of time, and limits your potential downside.

    1. yes, stop losses are your friends. It amazes me the amount of people out there that will invest, watch a company begin to implode, yet still hold onto their shares in a passive manner hoping that some magic stock market ferry will save the day…dream on.

      The market is not for lazy investors who want to put away money for another day. There are CD’s/GIC’s/Bonds. Get into a stock, keep a trailing stop loss to protect your investment and keep the emotions of making a million dollars on a single trade in a box under your bed!

      [email protected]’s last blog post: Back on Nortel!

      1. Alex says:

        Aman, I’ve tried ignoring your comments but it is painfully obvious you know nothing about the stock market. Stop losses, are not your friends… And the general upswing in the stock market, along with the mental attitude of a long term mindset is pretty close to the stock market ferry you mentioned.

        1. Please tell me why a stop loss is not your friend?

          Why dont you set a trailing stop loss. I am really curious how I know nothing about the stock market. How else do you protect your initial? Please tell me as I’m highly curious what your intentions are when the market tanks.

          If I bought $BAC back in October when it was in the high $20’s and did not have a stop loss (as a long position), my stock would have been worth as low as $3ish by now.

          As an investor for over 13yrs now with a very comfortable income from my trades, I am eager to have a lesson how why a stop loss is bad and how I know nothing.

          Btw, also while you create your rebuttal, please take into consideration why Forbes, Business Week, Investing for Dummies, and many other beginner and advances books emphasize Stop losses…I dont mind being called a lot of things, but telling I have no clue what I’m doing in the fields of medicine and business are two things you better come prepared to explain thoroughly.

          [email protected]’s last blog post: Back on Nortel!

  9. I personally won’t dabble in paper assets at present. Gold seems like the best investment best to me, and securing multiple income streams is also key to survival in the current economic climate.

    1. OOPS! I got my URL wrong for my prior post. Please fix it for me. Humble apologies!

  10. Fahd says:

    I agree completely. I would be buying right now if I had the money!

  11. Ebuka says:

    Neither buy and hold nor day trading will insulate any trader from massive losses. Both strategies are not without exposure to risks. But there one essential method to shield yourself from losses.
    Risk management is the strategy that savvy traders have always employed to make good trade. Studying the psychology of the public, you will find that all financial collapses are always preceded by mass hysteria and irrational appetite to make money without much work. If it were that easy, we will all be making millions. Get out when others are flocking in! You will be on the outside laughing at the idiocy of novice traders. A good BOOK that I recommend is : Extraordinary Popular Delusions the Madness of the Crowds by Charles Mackay. In this book you will see how Manias are created and how they pop. Perhaps you would have seen the market collapse so clearly. Good luck!

  12. buysellshort says:

    Market timing ABSOLUTELY works – long term investing? You may as well throw a match on your money cause after fees and inflation you make SQUAT. When everyone was capitulating 3 weeks ago we were BUYING and made 20-100% on stocks in that time. AND the market is still down 10% since January!

  13. euros says:

    Great commentary there, John. Gotta think long term, and remove yourself from watching the day to day or hour to hour fluctuations. And stop watching CNBC!

  14. Scarry outlook on the charts, but we have to survive

    Ari Lestariono’s last blog post: Depression Treatment: Tricks & Tips

  15. As per Ebuka’s post above, risk management is the key part to investing. And unfortunately investing passively has no element of risk management except in the narrow sense of reducing your risk to fee erosion of your investment returns.

    If someone is on this site and is taking the time and effort to try to make money outside of the “normal” channels such as a 9-to-5 job, then that someone should take the time to invest their hard earned money with some degree of active management with a focus on managing risk – particularly downside risk.

    Bear market rallies aside, it is a stretch to comfort people who have lost 50% of their investments since mid-2007 by saying that in the long run passive investing will get them there, particularly if that person is into their late 40s / early 50s even with appropriate lifestyle investing.

    Unfortunately, investing is a like gambling in many ways, and a good gambler will always tell you that more money is saved by managing downside risk than by getting calls right. Because no investor will get it right all the time – not even the great Warren.

    Masked Financier’s last blog post: Motley Fool thinks Investing is like Poker

  16. Honestly speaking I am not into these kind of investment and earning. For me this is a kind of gambling.

    I have tried few times but this kind of income is not on my card 🙂

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  17. Honestly speaking I am not into these kind of investment and earning. For me this is a kind of gambling.

    I have tried few times but this kind of income is not on my card 🙂 I will try in other way soon through stock market.

    [email protected]’s last blog post: Why website hosting location is important for search engine position

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