Putting money in the stock market can invoke fear in some would-be investors. Nobody wants to end up buying right when prices peak.
So how do you evaluate when it's a good time to buy and when to wait for a pullback? Well, if you're simply looking to buy a broad stock market index fund, the best answer is you don't. Even if you're an individual stock investor, there's usually some piece of the market that presents a good opportunity to invest your money.
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Is now a good time to buy stocks?
If you're looking to invest for your future -- five, 10, 40 years off -- then now is as good a time as ever to buy stocks. Waiting for a pullback in stocks with a long-term time horizon isn't going to move the needle that much. How much is a 10% difference going to make on your buy price today in 40 years when your original investment has grown more than 10-fold?
What's more, if you invest consistently over time -- putting more cash into your investments every month or so -- you'll end up catching a correction or a stock market crash from time to time. Those are opportunities to invest even more than usual if you can swing the cash flow. That said, it's not particularly feasible to plan for the unpredictable. If the market could predict a crash in stock prices, a crash would never actually occur.
If you like to research stocks, it might be harder to find good buying opportunities when the overall market valuation climbs higher. Fewer stocks will present value relative to their underlying fundamentals, but that doesn't mean those opportunities don't exist. It's always a good time to invest when you find a security you've determined to be undervalued by the rest of the market.
Warren Buffett once said, "I make no attempt to forecast the market -- my efforts are devoted to finding undervalued securities." For him, whatever the market is doing doesn't matter. If there's a stock with a good price, it's worth buying. Even if it goes down in the short run, trust the research you've done to produce long-term gains. But don't ignore the company entirely, and make sure your investment thesis is still valid.
Buying a growth stock with strong long-term potential near the peak of a bull market run is far from a death sentence. While growth stocks tend to fall much more in price amid a correction or crash, those periods can also be catalysts for growth. Economic events that shake up the stock market often present opportunities for companies with management teams focused on long-term growth opportunities. So even if your stock tumbles, it could come back even stronger.
Some investors may be scared off by a small pullback in price, thinking more losses are coming. In fact, it's much more likely to be a correction, meaning a drop of more than 10% but less than 20%, than a market crash, or a drop of more than 20%. Stock market corrections happen all the time -- an average of once every other year or so. They can be a great opportunity to buy stocks while they're temporarily discounted.
Why you shouldn't time the market
Some of the best investors in history had no interest in trying to time the market. Guys such as Warren Buffett and Peter Lynch have avoided market timing throughout their careers. If they don't recommend doing it, what makes you think you can outsmart them?
Lynch put it rather bluntly. "Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves."
Simply looking at a few statistics should show you why attempting to time the market is a big risk. If you invested all your money in an S&P 500 index fund at the start of the century, you'd see an average return of about 6% per year over the next 20 years. That period includes the dot-com bubble and the Great Recession.
But if you missed out on the 10 best days for the index during that period, you'd earn just 2.44% per year. You'd miss out on half the returns of the market. You never know when those 10 days are going to occur across the 20-year period, but you'd better have your money working for you when they show up.
Key factors to keep in mind whenever you invest
- Have a plan. What are you investing for? What's your time horizon? Is this a one-time investment, or do you plan to keep adding to it regularly? Answering these questions can help determine how you invest your money.
- Think long term. A short-term pullback in stock prices today won't have a huge impact on your long-term returns. It certainly won't have as big of an impact as missing out on just a few of the market's best days. And, if you buy stocks on a regular schedule by dollar-cost averaging instead of hoarding cash, it's highly likely you'll do better than trying to time the market.
- Understand volatility. Market values go up and down every day. Some stocks, such as growth stocks, are more volatile than others, such as value stocks. High-flying growth stocks that sink the moment there's a hint of trouble aren't for everyone. Pick stocks that fit your risk profile and tolerance for swings in valuation.
- Diversify. Investing across market sectors can help mitigate market forces that only impact certain industries. And, by exploring across market sectors, you'll be able to find more investment opportunities in any type of market.
- Expect to be wrong sometimes. If you're an individual stock investor, you're not going to pick winners every time. That's another reason why it's important to spread out your investments among several companies and sectors. Then, if your investment thesis turns out to be wrong, it's time to sell and put your money to work elsewhere.
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