Rebecca Hotsko (03:12):

What happens after a market crash was actually studied by William Goetzmann and Dasol Kim in a 2017 paper titled Negative Bubbles. In this paper, the authors looked at 101 global stock market crashes dating all the way back to 1692 through 2015 and they identified 1,032 events where a market declined by more than 50% over a one year period. And what they found common to all of these historical global market crashes was that there was a higher probability of large positive returns following a market crash. So, what this means is that getting out of the market during a crash could be one of the worst mistakes you make as an investor, because it’s very likely that you won’t get back in in time and you would miss out on the large gains that typically follow after a crash.

Rebecca Hotsko (04:01):

If we take a moment to reflect on the most recent bear market that we can now observe as history, being when the pandemic first hit in March of 2020, we can look back on this crash now and kind of audit our own behavior during this time. I think that we all remember how scary and uncertain this time seemed. The word unprecedented was used more than ever that year with the S&P 500 having one of the fastest corrections in history, falling 34% in just 33 days before bottoming on March 23rd of 2020. And then from there, the index recovered within just 181 days or roughly six months later to pre-pandemic highs.

Rebecca Hotsko (04:39):

The important thing I want to point out here is that when the market began to crash in February of 2020, many investors may have sold their investments because of the fear that this time was different. And during this time, I heard a lot of people say that they would just wait for the market to bottom before getting back in. The problem is that this crash happened so quick that if you didn’t time that bottom perfectly and get back in within 30 days from the bottom, you would’ve missed out on the enormous gains that followed. In fact, market recovered by almost 30% within just 30 days from the bottom, which we now know was March 23rd of 2020. To think of it another way, if you had invested in an ETF that tracked the S&P 500 and you had not withdrawn any of your investment during the crash, initially, you would’ve seen your investment drop by 34% in 33 days, but it would’ve recovered almost entirely in just 30 days after that.

Rebecca Hotsko (05:34):

Looking back, everything is obvious in hindsight, but at the time, there was no reason to expect the market would turn around that quickly. And it’s likely that if you got out at some point on the way down, you stayed out or got back in when it was too late and you likely missed out on the massive gains. Research shows that the cost of waiting for the perfect moment to invest typically exceeds the benefit of those that even manage to perfectly time the market. Again, this is because no one can reliably and consistently time the market perfectly and because market bottoms are only obvious in hindsight. So, the best strategy for most long-term investors is to just not try and time the market at all. Instead, investors would be better off just sticking to their risk appropriate and properly diversified investment plan.

Rebecca Hotsko (06:21):

Now, this isn’t to say that building up a nest egg of cash is inappropriate in some situations. I’m just talking about altering your investment strategy based on peer price speculation because you think the market will go lower. So, I was really curious to see what the data said about market timing and how an investor’s total wealth could change just based on what investment strategy you implement over a long period of time. And I found a great study conducted by the Schwab Center for Financial Research where the authors compared five investors who all implemented very different investment strategies to see how just investment strategy alone impacted their total wealth over a 20-year time period.

Rebecca Hotsko (07:00):

So, in this paper, each of the investors got the same $2,000 to invest every year and the only difference was when the investors chose to invest the money each year. It’s also worth noting that the investors all put their money in the same S&P 500 market index. So, the five different investment strategies the authors compared in this study was first an investor who was able to perfectly time the market. So, this investor was able to invest the $2,000 into the market every year at the lowest price, meaning right at the bottom before the market rebounded. And it was assumed this investor continued to time the purchase of their investments perfectly and got in at the market bottom every year for 20 years.

Rebecca Hotsko (07:46):

The second strategy was an investor that instead just used a consistent approach of investing the $2,000 in the market index on the first trading day of each year and they made absolutely no effort to time the market in any year. The third strategy they looked at was dollar cost averaging. And to do this, they divided the annual $2,000 into 12 equal portions and they assumed this investor put the money in at the beginning of each month for 12 months for 20 years. The fourth strategy they considered was an investor who was very bad at timing the market. And this person ended up investing the $2,000 each year at the market’s peak, meaning the seemingly worst possible time to invest every year, right before the market went down. And they did this every year for 20 years.

Rebecca Hotsko (08:34):

And the last strategy they considered was an investor that just left their money in cash investments every year and never got around to investing in stocks at all. This investor may have been someone that was always convinced that stock prices were going to be lower and they kept their money out of the market. And for the purposes of this study, the authors assumed this investor earned the rate of return of treasury bonds over the 20-year period. So, what did the authors find? Unsurprisingly, the market timer who was able to perfectly but unrealistically time the market every year for 20 years did end up with the most wealth accumulated, turning the annual $2,000 investment every year into over $151,000 after 20 years.

Rebecca Hotsko (09:20):

But what is more surprising and important to note is that perfectly timing the market didn’t win by that much. So, where these results get interesting is that the investor who made absolutely no effort to time the market and instead just invested the $2,000 immediately on the first trading day of every year, ended up with over $135,000, which is only a $16,000 or roughly 10% difference than what the investor achieved who perfectly bought in at the lowest point of the market every year for 20 years. Similarly, the dollar cost averaging strategy performed almost as well as investing immediately did, with the difference in total wealth between these two strategies ending up being less than 1%. The slight underperformance of the dollar cost averaging strategy compared to investing immediately was because of the 20-year time period used where in a typical 12-month period, the market had risen 75.6% of the time.

Rebecca Hotsko (10:20):

Now, this next part I found super fascinating where the authors found that even if you were someone who invested your money each year at the worst possible time every year for 20 years straight, while your investments still grew substantially over the period, and in this case, this investor’s wealth grew to over $121,000, which is nearly three times more than the investor that didn’t invest at all and just sat in cash. I think that these findings are really relevant today because a lot of you might have found yourself in a position where over these last eight months, you’ve been trying to time the market in a sense by waiting for the right time to get back in because maybe you’re worried that the market may continue to go down after you invest, so instead, you’ve just been sitting on cash, that in a best case scenario is just getting completely eroded by inflation.

Rebecca Hotsko (11:11):

But the reason I wanted to talk about this today is to remind us of the important investment principle which is time in the market is way more important than trying to time the market even if you invest in the market happens to go down after for a period of time. Time is still the single most important factor that will help us generate wealth as long-term investors. And I think this study perfectly illustrates this point that we don’t have to be perfect market timers to build substantial wealth. In fact, even if we accidentally invested at the worst possible time, being right before the market goes down, it doesn’t matter that much in the grand scheme of things. And in the long-term, it leads to a far better outcome than not investing at all.

Rebecca Hotsko (11:54):

Now, some of you might be wondering, what if these results are just time-specific to the 20-year period the authors chose which was from 2001 to 2020? Because to that point, this was a period where the market had an annualized return of 5.37% and quite low annualized inflation of 2.04% for the period, which is much different than what we’re experiencing today. Well, the authors also ran the same scenarios on all 76 rolling 20-year time periods dating all the way back to 1926 and they discovered that these results generally don’t change regardless of the time period considered. The authors also looked at all possible 30, 40, and 50-year holding time periods starting in 1926. And besides a few instances where dollar cost averaging did better than investing immediately, all of these time periods followed the exact same pattern as I discussed before.

Rebecca Hotsko (12:54):

So, what this all means practically for a long-term investor is that using either an immediate lump sum investing strategy or even dollar cost averaging pays off almost as well as perfect market timing did over the long run. And that has shown to be the case for 20, 30, 40, and 50-year time horizons. So, if you’re worried that the market may continue to keep going down, perhaps dollar cost averaging is the best strategy for you. And that’s one that I’ve personally been using over this past year, just to continue to lower my average price in some of my positions but make sure I’m still sticking to my strategy. So, I hope sharing this research helps remind you guys of what really matters when it comes to building wealth as a long-term investor, which is more time in the market.

Rebecca Hotsko (13:41):

And I hope that you keep these research findings in mind going forward as it may be tempting to try and wait for the best time to invest, especially in a volatile and uncertain market environment. But before you do, remember the high cost that comes with waiting and that wealth isn’t built in a few good trading days, but it’s built over the long-term by sticking to a consistent approach. All right. That is all I have for today’s episode. I hope that you guys enjoyed it. Let me know if you have any questions related to anything I talked about today. And feel free to reach out to me on any of my socials, they are linked below in the description, as well as let me know any topics you’d like me to cover in future mini episodes. Thanks for listening and I’ll see you again next week.

Outro (14:26):

Thank you for listening to TIP. Make sure to subscribe to We Study Billionaires by The Investor’s Podcast Network. Every Wednesday, we teach you about Bitcoin and every Saturday, we study billionaires and the financial markets. To access our show notes, transcripts, or courses, go to theinvestorspodcast.com. This show is for entertainment purposes only. Before making any decision, consult a professional. This show is copyrighted by The Investor’s Podcast Network. Written permission must be granted before syndication or rebroadcasting.