Is Now a Good Time to Invest? (2012 Update)

“Is now a good time to invest in the stock-market?”  is probably the most popular financial question I hear from readers. In this article, I will tackle this century old question and attempt to provide a few tips in how you can form your own timing strategies.

The widely held belief is that the key to stock market success is timing your investment. The common-sense mantra “Buy low, sell high” implies that one must spot when the stock market is ‘low’, and when it is ‘high’. The logic is as follows:

(1) If I had known better and had invested in that trough in the graph, I would currently be sat on a healthy profit.

(2) Therefore stock market timing is something I should let determine my investment strategy”.

However let me point out a flaw in this seemingly sensible argument. The argument above makes the false assumption that improving ones market timing is actually possible. Many academics and investors believe that in fact it is almost impossible for the average investor to achieve.

I know we all like to imagine that we are above average (much like with driving, where 90% of the population believe they are above average drivers), but the cold harsh reality is that a massive majority of stock market trades are made by professionals who have a financial education, live market information and swift trading software.

Hindsight is 20:20

The problem is that looking forward in the financial landscape is extremely difficult. Even harder is placing a current value on shares that will depend on this future landscape. Through the wisdom of crowds, the stock market manages to place a ‘best guess’ price on shares, that is, the price consensus that the market participants have individually decided upon. This valuation states that for a given expected cash flow, and a given level of risk, the price is x. Following on from this, the efficient market hypothesis states that because current prices incorporate all publicly available information, an individual can do no better than simply toss a coin to predict whether expectations of future returns will rise or fall in the next day.

So when are looking at past charts and see huge peaks or troughs, it is very easy to interpret them as such, and imagine that we would have ‘known’ that those would have been the right time to buy or sell. However in reality, we can only see whether it would have been a good decision by actually letting the market play out, and take a look back to see what happened. On the day you actually make a buy/sell decision, you will honestly have very little statistical probability of making the right call every time.

A More Important Rule Than Timing

Rather than placing ‘timing’ as the key investment success factor, my personal opinion is that actually being invested is much more important. One can wait on the sidelines for years during recessions and volatility, hoping for an ever more attractive price. But if one never actually commits to an investment, then you guarantee that you will never be successful in the stock market, and no doubt the market will rise without your participation after the crash. This phenomenon occurred in 2009, when the FTSE100 actually rose 18.35% during the year, despite all the doom and gloom surrounding a global credit crunch. Many retail investors had sold their shares in 2008 whilst they languished at a 10 year low price, only to miss out when the markets rebounded one year after. Such events highlight the true unpredictability of the stock market and expectations.

The Income Perspective

Rather than hopelessly pursuing the aim of out-witting the majority of market participants when you buy and sell shares, a positive alternative put forward by Monevator Blog amongst others,  is to view investing as purchasing units of annual income. This income will come in the form of dividends, and you will be able to target funds and companies that pay high dividends in order to optimize this strategy.

The key difference is that when you take the income perspective, you commit to hold the shares for the very long term – perhaps as long as 30 or 40 years. With such a long time horizon, the actual price of the shares is completely irrelevant, and this reduces or eliminates the need to generate capital gains from impossible market timing. If  you believe the current price offers you a decent enough divident yield to compensate you for the risk you’re taking, then invest your funds and ‘lock in’ that dividend rate.

The great thing about the income perspective is that dividends are much more stable than stock prices, and therefore you will lose far less sleep when you use income as your benchmark, rather than the value of your portfolio.

So… Is Now a Good Time to Invest In the Stock Market?

If you’re still looking for a wise expert to give you a binary ‘yes/no’ answer on whether to invest in the stock market, then perhaps investing for the long term isn’t really your game. The sensible advice for any investor is to drip feed your saved income into a stock portfolio (along with other asset classes) over the course of your life. This is a very sound strategy, and is the lowest-risk, highest-return strategy available in terms of timing. The bonus advantage of this method is that ‘Pound Cost Averaging’ means you buy more for your money when times are hard, and less for your money when the stock market rises, giving you a silver lining whichever way the market turns!

For more information on stock market investing, read How to Invest in the Stock Market.

Simon OatesIs Now a Good Time to Invest? (2012 Update)