Should I wait for a market crash to buy stocks?
We’ve all been there.
More often than not, I have looked at stocks that I wanted to own, but I couldn’t because I felt they were overpriced. And I hoped for a stock market crash to happen, so I could buy the same stocks at a lower price. I’ve also hoped for a market crash, just so I could get more returns on stocks I already own, as I can buy more of those when the market crash happens.
I think every investor, at least once in their lifetime, has wished a stock market crash would happen, or at the very least they’ve pondered over the idea of buying stocks during a stock market crash.
I hate to break it to you, but that’s a terrible idea. Let me tell you why.
Why you shouldn’t wait for a stock market crash?
Timing the stock market
People generally assume big institutions and seasoned investors on Wall Street have the ability to time the market, as they have a deeper understanding of how the market works than an average retail investor. The truth is, no one can time the market. It is not really a question of how much knowledge or experience you have, the volatile nature of the market just makes it impossible to predict the flow. Remember, not all stock market crashes were the results of a pandemic.
This quote from Peter Lynch, who managed Fidelity’s Magellan Fund (it had an average annual return of 29% over the course of 13 years), says it all: “Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections than has been lost in corrections themselves.”
Best days and worst days of S&P 500
This is another reason why waiting on the sidelines is a bad idea. According to this data going back to 1930, Bank of America found that if an investor missed the S&P 500′s 10 best days in each decade, total returns would be just 91%, significantly below the 14,962% return for investors who held steady through the downturns.
Since we can’t time the best and the worst days, hold on to your investments through highs and lows. In the end, the stock market will reward you with returns. As the old saying goes ‘time in the market beats timing the market’.
Buying stocks on dips
Contrary to popular belief, there are distinct differences between market correction, market crash, and a bear market. A market correction is a drop in value of at least 10%, and less than 20% from a recent high. A market crash is a sudden and sharp decline in stock prices, in one day or a week. Whereas bear markets are the long, sustained declines in stock prices across 20%, and it often takes months.
However, these are not common. What is common is a dip, which is a brief decline in stock price, which happens over a couple of days or weeks, and is often short-lived. While waiting for a market crash, retail investors generally mistake dips for a market correction or even crash, which often results in investors buying a lot of stocks, hoping to amplify their returns. That leads to losing on your gains in the long term.
” When will the stock market crash? “
Like I mentioned, stock market crashes are not common. They happen very rarely. Since 1965, there have been only 8 drawdowns of 20% or more in the United States, once every seven years on average. Here is something most retail investors neglect – there is always a cost to wait. What if it takes two years or four years for a market crash to happen? You’ll lose out on significant gains during that time.
A study conducted observed that from 1926 to 2016 the U.S stock market returned 6.3% over cash. When looked at investors who waited to invest until a correction occurred, then measured their returns 5 years after those corrections happened (period measured included waiting period, crash, then 5 years after the crash). Those investors that were disciplined enough to stay in cash until a correction happened, then put it all in the market for 5 years generated returns that were, about half of those they would have received if they just held stocks throughout the whole period.
That says it all. If you wait on the sidelines, with a lot of cash, not only will you lose its value due to inflation, at the same time, you will also lose out on capital gains, which you could have made if you had invested it in the market.
What you should do instead?
As it goes without saying, stop waiting for a stock market crash. Waking up every day hoping the world to end, so you can make some dollars is not how you want to spend your life. The problem with this thinking is that you actually assume that you can invest after a crash. Understand that it’s not as easy as it seems. You wouldn’t know at what point after the crash should you invest – should it be when the market is 15% down, or should I wait till the market goes down 20%? What if the market keeps going down?
You might look back at the events of March 2020, and think about the money you could have made if you had bought stocks during the crash. But in reality, it doesn’t work like that. When it is happening around you, when you see S&P 500 dropping points, it’s hard to put money into the markets, especially when you don’t know how long the downward trend will last, or what the future holds. Moreover, there is the fear of an impending recession or depression, which investors usually associate with a market decline.
Make the most of compounding
To quote the world-famous scientist Albert Einstein; ‘Compounding is the greatest mathematical discovery of all time’. Compounding, in simple terms, is generating earnings on top of your previous earnings. This simple example illustrates why compounding is significant in investing. If you invest $10,000 in the market earning 5% a year, in 20 years it would be worth $26,533. If you can manage to get that to 10% a year, the investment would be $67,275, in the same period.
For this phenomenon to work, three things are essential. The original investment should remain invested, the earnings should be reinvested, and the most important of all, time. The more time you give your investment to grow, the more exponential compounding effect, and more valuable your investment would be.
Use dollar-cost averaging
It is a strategy where equal amounts of dollars are invested at a regular, predetermined interval. The key to its success is sticking with the plan. By adopting this strategy, you will consistently put money into the stock market, regardless of how it is performing. With this strategy in place, you will buy fewer shares when the market is up, and more shares when the market is down, producing consistent returns in the long term irrespective of stock market crashes.
However, 95% of investors have been Dollar Cost Averaging wrong this entire time. Find out why on page 167 of our bestselling book The 8-Step Beginner’s Guide to Value Investing