The Cost of Trying to Time Corrections

While many investors don’t think of it this way, opportunity cost is money lost.

As this bull market matures, the punditry seems continuously engaged in advising you otherwise. It’s driving countless would-be investors to play a counterproductive guessing game: sitting on piles of cash—a low-yielding asset class that doesn’t match many investment goals—as they await a correction (a short, sharp, sentiment-driven dip of 10% or greater). If you require growth in order to reach your goal—and if you’re trying to fund retirement, build wealth or an inheritance, or ensure your savings earn returns that outpace inflation, chances are you do—you’d be better served to align your strategy with that than a guess about future volatility.

My sense is this sentiment is partly a lingering fear of heights and partly that folks don’t want to be stung by buying in and seeing red, even if it’s fleeting. Some investors likely rationalize these emotions—saying they’re simply trying to wait for a lower entry. But there is a big risk here: Timing a correction amounts to trying to time other folks’ emotional flips and flops.

The risk is the same as if you went down and sold—you’re missing money that would otherwise be there. A $100,000 investment in the MSCI World Index made the day the last correction in this bull market ended (June 4, 2012) would have grown to $155,628.70 as of June 4, 2014.ⁱ So not investing back then currently carries a sticker price equivalent to a fully loaded, V6 2014 Acura MDX. Or $3,000 cash and a brand new 2014 Audi Q7 TDI Premium (they’re flashy). Or a bit more than a year’s tuition, fees and books at Columbia University! (Also flashy.) Maybe your goals are less flashy than these luxuries. But allowing cash to sit idle—out of step with your growth goal—is a mistake whether those goals are to rent Versailles for your daughter’s wedding or just ensure you’re not living in your daughter’s basement a few years later, wherever she was wed. (Not flashy.)ⁱⁱ

Correction timing is impossible. Sentiment-driven stock market moves are not like busses. They don’t operate on a schedule, so that there has not been one in two years doesn’t really mean one is “overdue.”ⁱⁱⁱ There is no due. (Just like there is no “normal” or “mean” things should revert to in investing.) In the 1990s, there was no correction between April 8, 1992 and July 20, 1998. (A dip in 1997 came close.) The first correction in the 2002-2007 bull market began June 13, 2006—more than three years after the bull began. The next one took place the following summer. There were zero corrections in the short bull market from 1987 – 1990. There is just no regularity to these events. Trying to guess when a correction will occur is speculating on short-term market direction. And it’s not important to avoid corrections if your time horizon is commensurate with equity market investing.

Let’s say, for example, you bought into this bull market on the day preceding a correction—presumably, what those timing a correction would consider the height of folly. We have five examples to look to in the present bull market.

The table in Exhibit 1 shows the hypothetical investment of $100,000 in the MSCI World Index on the eve of the five corrections in this bull market and the same if you bought perfectly at the bull market’s bottom on March 9, 2009.

Exhibit 1: Hypothetical Investment of $100,000 on the Day a Correction Began

Source: Factset, MSCI World Net Return Index as of 06/05/2014. “Current Value” assumes $100,000 invested on the date indicated and held until the present with no changes. You cannot invest in an index. Index fund, yes, but that’s for another day.

There is little doubt that corrections aren’t terribly enjoyable to endure, but their randomness and the fact they come and go so quickly shows they aren’t catastrophic. This isn’t to downplay the fear and negativity you may feel when going through a correction. Nor is it to say you wouldn’t be better off if you somehow nailed the low or thereabouts. You might be. But that also means buying when fears are high and rising and, in my experience, most folks who fear heights and a correction don’t find comfort in sharply negative volatility. The number of folks who say they are waiting for a correction far exceeds the number who actually buy when a correction arrives. Practically speaking, though, there is no consistent way to forecast the short-term blips and dips. However, perhaps you can take some solace in the fact downside was fleeting and in every instance in this bull as of now, the investor who sat tight is up.

Now, if you needed all or some of your funds on July 5, 2010, or at the bottom of any of these corrections, that’s another story. But if that’s the case you shouldn’t be investing in stocks in the first place. Maybe not even many types of bonds. Small time horizons are never conducive to investments subject to volatility. But for longer-term investors, the enemy isn’t a correction—in some ways, it’s not even a bear market—it’s more how you react to those events. Or in this case, the absence of those events.