SP500 Investing Basics: Timing is everything.
A practical guide on how to use time as an investment tool.
With respect to market timing, there are many who feel that timing the market is a waste of time. There are many who believe that no one truly can time the market, but what if I can show you that time does matter. This essay isn't going debate the value of trading investments, but it will demonstrate that even if you don't use technical indicators, mathematical models, or numerical strategies to make investments, it pays to know when the right time is to invest. The following facts may surprise you and may even make you more cynical with regards to how the odds are stacked against you to make money on Wall Street.
Let's explore a few simple ideas as to when to invest. The following ideas don't use any fancy modeling or technical indicators. The following three scenarios just invest the same amount money ($5,200 per year) into a no load SP500 mutual fund at various times and intervals. No dividends were included in this scenario because the focus of this study is how time affects capital appreciation. Total return isn't the point of this essay. These are real concrete examples that are not subject to averaging or other statistics such as confidence bands, standard error of the means, standard deviations, etc. These scenarios are actual investments made on specific dates that produced real results since January 1997.
It's as simple as it gets. The question being answered is when should I invest my money? Period.
By the way, in case you're wondering why only the last seven years were used in this study, this is because the tax laws changed in 1997 which changed the behaviour of traders. They could no longer "Short against the Box". This was a sneaky strategy to pay less taxes this year and defer capital gains to the subsequent year. So the data selected represents the same rules and trading behaviour. The rules of the game (investing) are consistent since 1997 (alot of analysts forget this little detail).
1. Annual - Let's say that you could invest $100 a week. That would amount to $5,200 per year. Now let's assume that you invest your money in an SP500 mutual fund in one lump sum each year. But what if you picked the same day each year to invest such as the last week in March because it's time to do your taxes and you are going to put money into an IRA. That's a good thing isn't it, because every financial advisor worth their salt will tell to save for your retirement. Plus, putting money into an IRA reduces your taxes today and allows you defer paying taxes on your capital gains until you retire. It's a win-win situation, or is it? Below is a graph of the results of investing $5,200 each year since 1997.
Notice that the worst time of the year to invest in the stock market is precisely when you're ready to put money into it (between the 21 and 51 trading days of the year). The graph below shows the number of trading days in the year and the total amount of money you would have on the seventh year. First, you would have invested $36,400. Notice that you would not have made any money over the seven year period. Even worse, you would have lost $9,000, or 25%, had you invested in March and April each year. The graph shows you that the best time to invest was between late September and October (between the 181 and 201 trading days). Had you invested your money during that time frame you would have almost broke even but it's better than losing $9,000. All you had to do was to invest 6 months later and you would be $9,000 richer. In addition, let's not forget about dividends. Although this essay doesn't include the value of dividends because the timing of price appreciation is being studied, the additional income received from dividends would bring you above break even but not by much. So if dividends were included, you would have made a few hundred dollars more.
The point here is that despite the convenience of investing in IRAs when you do your taxes, this convenience costs you plenty. In this case, following the crowd and investing during the same time of the year as everyone else costs you an extra 25%. So the answer to this is to plan to invest in your IRAs 6 months later.
The difficult part is in deciding to skip your tax deduction this year or invest only half of your IRA in March-April and the other half in Sep.-Oct. This unfortunately means that you won't be able to take full advantage of reducing your total income, but the plan is to shift the timing of your investments to Sep.- Oct instead of Mar. -Apr. This shift will mean that either you skip an installment to your IRA or half of it. Of course you could invest the full amount in your IRA this Mar. -Apr. and again fully invest in your IRA Sep.-Oct. which would count towards the following tax year but most of you won't have the cash flow or the funds available to invest in the fall after investing in the Spring.
It just figures that Wall Street has managed to get prices higher in the spring so that when you're ready to invest you're buying high instead of buying low.
2. Monthly - Next let's create another scenario. Let's assume that you don't have $5,200. So it would be better for your budget to invest money each month. So if you divide the $5,200 into twelve equal installments, you get $433. Again, let's invest it on the same day each month and see what happens. First, notice that investing on the same trading day of the month produced less than investing one lump sum. This was surprising since there are many who invest in this manner of monthly installments. The best you could have earned monthly is $35,040 while the highest total investing in one lump sum annually earned $36,070. So there's a potential difference of $1,000 just between investing annually versus monthly. However, if you look at the Monthly chart you'll see that the lowest you could of earned was $34,050 while the lowest for the lump sum was $27,250. So investing monthly was a great equalizer and a good strategy to average in.
In case you're wondering if there's a way to get back the missed opportunity of earning that additional $1,000 you could make if you invested one lump sum each year in October; there wasn't any way to recover that $1,000 differential. Even if you were to park some of the monthly installments in your bank account and make more installments after August when SP500 prices are typically lower than in the Spring, there wasn't anything to be gained by doing this. Basically, making automatic monthly installments works fine.
The next observation is that for some reason the best days to invest within the month are on the eighth trading day of the month and the nineteenth trading day of the month. These days produced the most money. Investing mid-month from the 11th through the 15th trading day of the month was the worst time to invest. So for all of you that make automatic installments mid-month, call you broker and change your schedule to make it more favorable for you instead of Wall Street. They're counting on those mid-month installments and apparently SP500 prices are higher during that time. Just make sure that you invest on one of these four days of the month: 8th, 9th, 19th, or last day of the month.
3. Weekly - Next let's invest the same day every week. For example, let's invest every Monday then let's compare this to investing on Tuesday, etc. Now we're investing $100 every week and let's see what happens. Well, once again Wall Street does a good job of taking it's share. Most investors have little time to manage their money and so decisions routinely are made over the weekend and orders are placed for Monday. As you can see, Monday is the worst day of the week to invest your money so place your orders on Tuesday instead. The difference between investing on Monday to Tuesday was $2,500. So waiting to place your order one day pays, but again investing on an installment basis wasn't as good as investing annually in the fall.
What was interesting here is that investing $433 a month or $100 a week produced the same results So invest whatever you can on an installment basis on either a weekly or monthly basis. You won't be penalized for choosing one over the other. Just try to invest every Tuesday, or on the 8th or 19th day of the Month. You'll make more money.
Caveats
The main point if this essay was to demonstrate that you could improve your returns by using time to your advantage. So this essay presented in a different context for the phrase "Market Timing". However, perhaps you can see two additional opportunities if you read between the lines of the main message.
Since there are sizeable differences between investing in different months, the "Lump Sum" chart is showing you an annual cycle. This happens to be a tradeable cycle. But before I explain how you can do this, first let me explain the chart a bit more. As discussed, you make the most money by investing in the Fall and you make the least in the Spring because you're able to purchase more shares with your money in the Fall than you can in the Spring.
This translates into actual SP500 prices that are opposite the peaks and troughs displayed in the chart. The alternative meaning is that actual SP500 prices must generally be higher in the Spring and lower in the Fall. So this chart is inversely related to actual SP500 prices. Where the chart shows you that you can make more money is when SP500 prices are generally lower and where the chart shows you that you will make less money is when SP500 prices are generally higher.
But, please note that this wasn't the case in 2003! Prices were lowest in March and highest in the Fall. So this didn't work 1 out of the last 7 years. This is still a good strategy but be aware that nothing is guaranteed or 100% predictable. Investing isn't a science.
The second caveat is that perhaps you could take advantage of this apparent seasonal pattern. You could ...
Basically, you could become more creative and take advantage of this annual cycle. But don't forget to factor in your tax liabilities and other personal consequences.
With respect to the monthly chart, notice that there also exists a tradable cycle. Again the chart doesn't show the actual fluctuation of SP500 prices, but rather the amount of money that you would earn if you invest during that day. So, the actual SP500 prices would generally be inversely related to the chart.
For those of you who are inclined to make short term investments, this may be a a new pattern for you to exploit. You can ...
You could also investigate which months have the strongest cycle so that you trade more aggressively during the months which demonstrate a greater likelihood of success.
Essentially, the charts presented can be reinterpreted to demonstrate trading cycles that have not been presented to you before. How you take advantage of these cycles is your choice, but don't take on any additional risk of increased losses that you can't afford and remember to consider all financial consequences before implementing a new strategy. Don't forget to factor in tax liabilities, transaction costs, margin requirements, last trading day, expiration day, and don't lose perspective with respect to your financial goals. We all want to make a million bucks. It's about how you get there without going broke.
Summary
First let's review the dismal reality. Regardless of when you invested in the SP500, you would have lost money had you regularly added money to the SP500 mutual fund. Buying shares in the Mutual Fund on an annual, monthly, or weekly basis did not produce $1 of profit in capital appreciation. Your total return may have helped you to do better than break even, but you didn't beat the system by investing. So who's making millions on Wall Street and how are they doing it? Clearly buying and holding isn't working for those who purchase shares since 1997. Had you purchased bonds rather than stocks during the same period, well, you wouldn't have made a million either, but you wouldn't have lost money. So stocks weren't the place to invest. But when you do invest in stocks, this essay showed you how to select more wisely when to invest in stocks.
It's interesting to note that market timing doesn't have to be very sophisticated. You don't need a computer or expensive software. If you were to consider investing you could easily make an additional $2,400 by placing your order on a Tuesday rather than on Monday. You could make $1,000 more by investing one week earlier on the 8th day of the Month rather than on the 15th, and lastly, you could earn an additional $9,000, or 25%, for simply investing in your IRA during Sep. - Oct. rather than in March or April.
Implementing these ideas wouldn't require much on your part and after all, it's your money. So why not use time to your advantage. As you were shown, Wall Street knows when the average investor is going to invest and somehow the average investor always pays more and gets less in return. Don't be an average investor, be a smarter one.
created 12/9/03, The Small Investors Software Co. All rights reserved.