The mainstream media often discusses the stock market with a short-term mindset. Even worse, pundits often promote market-timing strategies. They draw arbitrary lines on charts to explain when it's time to buy or sell, and it often sounds very sophisticated. But the data is clear: Market-timing strategies are prone to failure.
After analyzing how the S&P 500(SNPINDEX: ^GSPC) performed in the first 10 months of 2024, Goldman Sachs analysts wrote, "While investors may want to wait for a better entry point, we believe that the potential benefit of investing, even at an inopportune time, outweighs the downside of not investing at all."
Time in the market (not timing the market) is what matters. Indeed, one of the worst mistakes investors could have made in 2024 was to sit on the sidelines. Read on to learn more.
Avoiding the stock market has been a very costly mistake in 2024
While valuations have been elevated throughout 2024, investors who avoided the stock market have likely paid a very high price. Consider three hypothetical portfolios with money in an S&P 500 index fund. All three had $10,000 invested at the beginning of this year, but their strategies differed thereafter.
Portfolio 1: The investor never added money because they were waiting for a better buying opportunity due to valuation concerns.
Portfolio 2: The investor added $1,000 per month with perfect timing, meaning they bought shares at the low point each month.
Portfolio 3: The investor added $1,000 per month with the worst possible timing, meaning they bought shares at the high point each month.
It's natural to assume Portfolio 2 performed best because the investor had perfect timing. It's also natural to assume Portfolio 3 performed worst because the investor had the worst possible timing. But only one of those assumptions is correct. Listed below are the values of the hypothetical portfolios after the first 10 months of 2024.
Portfolio 1: $12,742 (a gain of $2,742)
Portfolio 2: $25,452 (a gain of $5,452)
Portfolio 3: $24,957 (a gain of $4,957)
Clearly, avoiding the stock market in 2024 could have been very costly. Portfolio 2 is worth $585 more than Portfolio 3, so perfect timing offered a small benefit versus the worst timing. But both did better than Portfolio 1. The owner of that portfolio made about half as much money as the other two investors because they were always waiting for a better opportunity.
Bears often sound smart when explaining why the stock market is due for a correction, but attempting to time a market correction is a great way to miss out on gains. Famous investor Peter Lynch once warned that "far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves."
In short, it generally makes more sense to continue investing through good times and bad. Stock market corrections are unavoidable, but attempting to time those corrections often leads to losses. Moreover, the S&P 500 has recovered from every correction in history, and the market tends to go up more than it goes down.
Image source: Getty Images.
The S&P 500 is historically expensive headed into 2025
The S&P 500 had a forward price-to-earnings (P/E) ratio of 22.2 as of Dec. 20, according to Yardeni Research. That is above the five-year average of 19.7 times forward earnings and the 10-year average of 18.1 times forward earnings. In fact, the index has not traded at such an expensive valuation since April 2021, according to FactSet Research.
Dating back to 1980, the S&P 500's forward P/E ratio has topped 22 during only two periods: (1) the dot-com bubble in the late 1990s and (2) the stock market melt-up that followed the onset of the COVID-19 pandemic in 2020. The S&P 500 ultimately declined sharply both times.
So, on one hand, history says avoiding the stock market can be a costly mistake. But on the other hand, history also says forward P/E multiples above 22 are eventually followed by a correction or bear market. Investors can reconcile those opposing data points by tweaking their strategy in 2025.
Specifically, anyone buying individual stocks should be particularly cognizant of valuations. Many stocks are historically expensive, and fear of missing out is not a good reason to buy. Instead, look for stocks that trade at reasonable prices and consider buying fewer shares than normal.
Alternatively, anyone buying an S&P 500 index fund should invest at a slower pace. If you typically invest $400 per month, consider reducing that figure to $200 per month. Keep the extra cash in your portfolio. That way, when the next correction comes around, you will be able to capitalize on it.
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Trevor Jennewine has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends FactSet Research Systems and Goldman Sachs Group. The Motley Fool has a disclosure policy.
