The Shocking Returns Of The Investor Who Bought Only At Market Tops

Summary

• The S&P 500 is at an all-time-high.
• The idea that the stock market is in bubble territory and about to collapse is a recurring theme that scares and pushes many investors away.
• Nobody can predict when the next market crash will occur. But what happens if you consistently invest at the worst possible time?
• To find out, I estimated the returns of an investor who would stay in cash before going all-in at all market peaks for the past 50 years.
• The results might surprise you.
• Looking for a portfolio of ideas like this one? Members of App Economy Portfolio get exclusive access to our model portfolio. Get started today »

Some things never change.

When the market reaches a new all-time-high, many pundits come out of the woodwork to express skepticism on what the future may hold. They express their high degree of pessimism and suggest investors should hunker down, raise cash and wait for a large pullback.

As explained before, when it comes to investing, I believe being an optimist is a superpower. When you look at the past 150 years, the stock market has been an outstanding wealth-creation machine for those who embraced it. The market inexorably rises in the footsteps of GDP growth, while the world goes through challenges of all kinds, from wars, financial crises, crashes in commodities, to pandemics.

This has prompted me to:

• Keep a long-term mindset.
• Invest in the stock market like a venture capitalist.
• Embrace the art of not selling.

Source

While I have zero insights on where the market is going next, I'm always fascinated to hear about people who are eager to be out of the market and stay in cash for years on end, just to be able to say "I told you so," when the next sell-off inevitably occurs.

Yes, market crashes happen, and I wrote an entire article about how to prepare for it. As a reminder, here is the historical frequency of pullbacks identified since 1928:

Market drawdown	Historical Frequency
10%	Every 11 months
15%	Every 24 months
20%	Every four years
30%	Every decade
40%	Every few decades
50%	2-3 times per century

Click to enlarge

According to a research note from Bank of America Securities, the average time for the market to get back to where it was after a drawdown of 20% or more is 4.4 years. This is why most advisors recommend to invest in equities only if you intend to hold your investment for the next five years. Even assuming you have terrible timing and invest right before a bear market, you will still have a good chance to be back in the green after five years.

Volatility is a small price to pay to reap the rewards of market returns compounding over decades. After all, the S&P 500 (SPY) (IVV) (VOO) has returned almost 4,000% in the past 50 years.

Data by YCharts

But to get there, those who started their investing journey in 1970 have gone through hell quite a few times.

Here is how the many market sell-offs look like over time.

Data by YCharts

Over the past 50 years, the S&P 500 benchmark went through:

• 26 market corrections (declines of 10% or more, see below).
• 6 bear markets (declines of 20% or more, highlighted in red).
• Among them, 3 market drawdowns of more than 40%.

Source

This certainly illustrates why a "buy and hold," strategy is a sound principle, but incredibly challenging to execute. Learning about market history and understanding that they are a natural part of the process can help you stay poised the next time volatility knocks on your door.

With this in mind, many investors constantly live in fear of a market crash. And I believe the best way to address such a fear is to try to evaluate what the worst that can happen really is.

• What would be the returns for the unluckiest investor among us?
• How bad would be the returns of someone who would invest in the market in lump-sums at the worst possible time, with consistency, for five entire decades?

To find out, let's solely focus on bear markets, since they represent declines of 20% or more from the previous high. In this hypothetical scenario, let's imagine the track record of one of the worst market-timers of the past 50 years. We'll call her Amy.

In 1970, Amy is 20 years old. She manages to save $1,000 per month from her income every month for 50 years (well done, Amy!), all the way to the end of 2020. Amy is now 70 and is starting a well-earned retirement.

Instead of investing regularly in the stock market, let's assume that Amy dumped all her available savings in an S&P 500 index equivalent at each of the peak prices that preceded a bear market. Amy would invest exclusively in lump sums, ignoring the ways to invest that can make you rich (very slowly). This would certainly give her the status of "worst market-timer."

For this exercise, we are going to assume that Amy's money invested in the stock market is remaining invested all the way through the end of December 2020, regardless of when it was invested. After all, when you see your brokerage account collapse every time you add money to it, the only path forward is to stay invested for the long run and hope for the best. This will also make this exercise much easier to digest since we don't need to factor in any taxes.

Here is what Amy's investing journey would look like:

• Amy would save $1,000 for 36 straight months starting January 1970.
• In January 1973, Amy would invest all of it at market peak, right before a 48% crash.
• Amy would go on to save $1,000 for 72 straight months, piling up cash.
• In November 1980, six full years of savings or $72,000 would be dumped on the market once again right before a major bear market, with the S&P 500 about to collapse by 27%.
• We follow this logic all the way to the most recent sell-off that occurred in February 2020 with a global pandemic causing another major drawdown.

Here are the returns achieved by Amy:

Annual returns representing internal rate of return (calculated via XIRR) based on the dates Amy invested. Returns excluding dividends, taxes, trading fees, and expense ratios from index funds or ETF to match the S&P 500.

Amy was able to save $603,000 over her 50-year long career. And despite investing it in the stock market at the worst possible time every step of the way, she's left with $5,109,468 on her brokerage account. Yes, just like that, Amy returned more than 8 times her money and became a multi-millionaire. Using XIRR (internal rate of return based on the sum invested and at what date), Amy achieved 7.4% in annual returns.

She didn't need to invest in Tesla (TSLA) or Bitcoin (OTC:GBTC). Nor was she an early investor in the FAAMNG stocks (Facebook (FB), Apple (AAPL), Amazon (AMZN), Microsoft (MSFT), Netflix (NFLX), Alphabet (GOOG)). She didn't need to time the market particularly well. In fact, her timing couldn't have been worse. And she simply held on.

It's important to note that these returns don't factor in dividends or taxes, to keep things simple. But Amy's returns would be all the more impressive if we included the average 2.87% yield of the S&P 500 since 1970. Amy would likely have ended up with a retirement nest-egg above $10 million with re-invested dividends.

I've excluded the impact of trading fees (which would be zero today, but much higher back in 1970). Amy would also have had to pay some form of expense ratio to be invested in the S&P 500 throughout the years. That being said, you can find ETFs following the S&P 500 with expense ratios as low as 0.03% today such as the Vanguard S&P 500 ETF (VOO).

By now, you're probably wondering how much better Amy would have done if she had been a much more consistent investor. What if Amy had instead decided to invest $12,000 per year, dollar-cost-averaging in the stock market without ever skipping a year for 50 years? Here again, using XIRR (internal rate of return based on the sum invested and at what date) and the historical annual data of the S&P 500 in the past 50 years, Amy would have achieved 8.2% annual returns.

Make no mistake, while 0.8% improvement over our original scenario doesn't sound like much, it would have led her to reach a total amount of $8,565,976 on her brokerage account. That's a whopping extra $3.5 million for her old days. But the key here is to understand that Amy would have done extremely well no matter what. Because she stuck to a lifelong commitment to investing in stocks by staying invested for several decades.

While past performance is no guarantee of future results, what should remain with us from Amy's story?

• Saving more is the most efficient way to grow your wealth. That's even more true for young investors who need to build a stash to invest.
• Avoid worrying so much about the market being in a bubble or the next crash being upon us. Even investing at market peaks with consistency can't get in the way of your success as long as you hold on and remain focused on the very long-term.
• Start investing early, since you'll need many years for the magic of compounding to be the most impactful.
• Keep a positive outlook on what the future may hold. It will help you stay the course, which is the most important recipe to invest successfully, even assuming you have the worst market timing.
• Don't invest in lump sum. Since there is no way to know what the market will do next, stage your buys over time to factor for volatility.
• Your temperament is the greatest factor to your portfolio's returns. By simply staying invested for years on end, you'll likely do much better than most.

Wherever you are in your investing journey, I hope this article will serve as a reminder that there is no point in living in fear. You'll find negative voices everywhere, starting probably with the comment section of this article. But it's entirely up to you to pay attention or to ignore them.

Your best bet is to stay away from pessimists because their belief tends to be fulfilling. To end on a note attributed to Confucius:

Those who think they can and those who think they can't are both usually right.

Which one are you?

Disclosure: I am/we are long AAPL AMZN FB GOOG NFLX VOO CRWD ESTC PINS ROKU SFIX TWLO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.