Let’s create an economic rational and define our expectations when investing in the stock market.
Historic Returns of one-time investments
Historic data can show empirical evidence for certain pattern. The following overview shows historic performances for all investment periods between 1970 and 2020 into the MSCI World Index. The same exercise can be done for longer timeframes and different indicies but they show a similar picture.
Looking at longer periods we can see that the nominal return is always positive. This is the reason why stock investment timeframes of at least 10 years, usually 15 years are advocated.
As you invest one time at the beginning of the investment period a crash shortly after will result in a notable reduction of overall return even on longer timeframes. As an example, working your way back from an initial loss of 50% requires a gain of 100% and that takes time.
Historic returns of savings plans
Now let’s change our perspective and take a look how continous investing, like a savings plan, influences the performance overview. The rentability overall is (unsurprisingly) the same.
There is a notable difference on average returns over longer time periods. While the returns of a one-time investment is most negatively influenced by a crash at the beginning of an investment period and then averages to the mean over time, the savings plan builds up capital continously and a sharp drop at the end of an investment period leads to a drastic reduction of its average return.
Savings plans will tend towards the mean much faster as the growing amount of money invested will have a bigger influence to return to average returns.
So what do we take away from that? Other than buy low and sell high, that is.
First of all, you should be damn sure you are not buying into a bubble with a big amount of your money at one time. Sadly, as a bubble is really only defined but it popping, it’s hard to say when late is too late to invest. On the other hand if you start buying what feels to you being after a crash you can make sure that you invest only a portion and then have a look how things develop, so you buy thoughout the bottom building and shortly after that.
A psychological pattern is the socalled ‘fear of missing out’. If you feel you just have to buy anything because all are doing it and it has already ran so high that you can no longer wait, it might be the time to take a step back and reevaluate the situation calmly.
What we can also take away from this is, that a savings plan is pretty good in navigating the wrong time to get in, but can lead to negative surprises when it is time to get out. Therefore getting out should be planned ahead of time more carefully than with one-time investments, at least if we reference average returns. Mind, it makes sense in both cases to shift risk toward less volatile investments before the end of the investment period.
Finally there is one important observation to make that is often missed. As volatility in returns becomes lower over longer investment periods, returns tend toward an average, or maybe natural, return of 7–8% on equity (before cost, inflation and taxes) within companies, that seems to be enabled by the surrounding economy.
Projecting that into the future would mean that you can statistically expect an average return on your investment of 7–8% per year. The same time you would miss out on 7–8% on average by not being invested. So if you’re waiting for the right moment to invest long enough, you loose out on more than the next crash might cost you.
Disclaimer: I wrote this article myself. What I write is my personal opinion. I am not a professional finance consultant and this is not an investment advisory. I am not receiving compansation for this (besides maybe medium).
A certain development in stock market price cannot be guaranteed. Buying stocks can potentially lead to a loss of money up until loosing all of the invested money. All information is subject to error and could be outdated once you read this. The information I am giving does not replace an individual professional advisory that is considering your personal situation, goals and your ability to bear risk. Any liability or guarantee for the correctness of information given in this article is excluded.