Young & Invested: How I am investing through the market volatility
Some perspective for those scratching their heads at markets right now.
Welcome to my column, Young & Invested where I discuss personal finance and investing for Gen Z and Millennials. This column aims to be a resource for young investors navigating an ever changing financial, political and social landscape as they try to build wealth. Tune in every Thursday for the latest edition.
Edition 12
Even if you’ve never invested before, it was hard to miss the onslaught of news headlines last week following the market’s reaction to Trump’s tariff roller coaster.
In a long history of market crashes, the Covid recovery has been the quickest so far, and also the only one many younger investors have encountered. Many of us are filled with the natural optimism that comes from missing out on the experience of a prolonged, soul-crushing market decline.
The rise of ‘financial advice’ through social media such as Instagram, Reddit and TikTok leaves a generation that is rather new to investing, at the mercy of buy and sell signals from their favourite influencer.
But somewhere between proclamations to “buy the dip!” or “sell everything!”, there lies a call for rationality.
Volatile situations create bad investors
I’d be lying if I said the I didn’t consider offloading my life savings into the market last week. And I’m sure I’m not alone.
Faced with the largest meltdown since June 2020, on the surface there was a compelling argument to invest at a low point of what has been an expensive market over the last few years.
The psychology of fear and FOMO (fear of missing out), especially after seeing the post-Covid bull market left me wondering whether this was the investing opportunity of a lifetime. However, I’ve learnt the hard way that the best practice is to stay the course and avoid reactionary investing.
The truth is – market volatility creates bad investors. And by bad investors I mean the ones that make poor decisions in the face of uncertainty. In fact, Morningstar has aimed to quantify this phenomenon.
Our Mind the Gap study aims to examine the gap between investor results and reported total returns of a fund. Our findings showed that the average dollar invested in US mutual funds and ETFs earned 6.3% per year over the 10 years to Dec 2023, which was 1.1% less than the average fund’s total return over the same period.
This gap in fund and investor returns stems from mistimed purchases and sales, likely driven by emotionally irrational decisions. The study notes that the pandemic was a particularly difficult time for investors as many incurred heavy timing costs in 2020 (leading to an even wider 2% gap that year).
The biggest takeaway here is that the volatility we experienced during the Covid pandemic clearly amplified the returns gap, inferring that we tend to behave quite poorly during periods of high volatility.
You may read this and think that the 1.1% cost of poor behaviour sounds negligible, but for those investing for the long term, it can lead to a significant difference of wealth at retirement. Investing $1000 a month for 40 years and returning 6.9% will net you $2.4m, whilst earning 8% will yield $3.2m – an almost $1 million cost of a returns gap.
Can you time the market?
My inclination, and that of many “buy the dip” investors was last week’s temporary deflation of markets served as a timely entry point to a historically expensive market. However, trying to time market lows is often like trying to catch a falling knife.
As we saw last week, the market quickly rebounded from an almost 5-year low to its best day since the GFC. There are few investors that would have predicted that outcome.
Although any mention of “time in the market, not timing the market” may solicit eyerolls from seasoned investors, it provides some much needed perspective for younger investors who may blur the lines between gambling and investing.
Timing the market generally refers to making investment decisions based on the perceived attractiveness of the market. This includes abstaining from investing if the market is perceived as expensive and waiting on the sidelines in hopes of a pullback. Alternatively, it can also mean exiting the market when things become volatile and investors are worried.
Below is an example of the impact of time in the market vs timing the market which for most investor is an unsuccessful endeavour. If you were to put $1000 into the S&P 500 in 2004 and stayed fully invested, you would have over $7000. If you missed just the 10 best trading sessions, you would be left with under $3500.
Figure 1: Annualised performance of missing the best days of the S&P 500. Source: J.P. Morgan Asset Management.
But what if your investing strategy was to buy every time the market dipped a certain percentage? Would this work?
Let’s run this hypothetical scenario: Paul and Steve are both 25 years old and are looking to invest for another 40 years till retirement. Both started with a principal investment of $1000 but Paul was making monthly contributions of $500 whereas Steve only invested when the market fell by 10% from the current all-time high. In the meantime, when the markets weren’t falling 10%, Steve would keep his money in a savings account earning 2% per year.
Below is the result of these two styles of investing.
Figure 2 and 3: Portfolio value of timing the market vs time in the market. Source: The Measure of a Plan. Market timing simulator.
The green plot is Paul’s consistent contributions, and the orange is Steve’s result from only investing during dips of 10%+. After 40 years Paul would have accumulated $3.36m whereas Steve’s portfolio would be worth $2.87m. In this case, the difference of $500k during retirement is the opportunity cost of trying to time market lows.
How I am investing right now
The reality is, we are only 13 weeks into Trump’s presidency, and it appears markets may continue to act in erratic fashion.
For those dying to uncover some kind of groundbreaking investment strategy right now, I hate to disappoint. Contrary to my initial inclination, I did not offload my life savings into the markets last week. Thankfully, in my six years of investing, I have learnt to think through my decisions.
I am the first to admit that at my worst, I am an emotional investor. In the past, both fear and greed have dictated my choices leaving me worse off 99% of the time.
In a previous edition of Young & Invested I explained why I don’t invest in individual stocks anymore, and I find that philosophy to be incredibly helpful right now. It keeps me grounded to a ‘business as usual’ mindset rather than digging through the bargain bin for last minute deals on stocks.
I am investing with the goal of achieving a $100,000 portfolio (excluding superannuation) by the age of 30. This goal is achievable. Often attempts to time the market are driven by the pursuit of unreasonable return expectations. In life we’re told to “reach for the moon and land in the stars”, encouraging us to pursue goals that appear unattainable. Whilst heartwarming, this is not a recommended investment strategy.
My current strategy is to dollar cost average (“DCA”) ~$1,500 per month until I reach this number. Now this may come sooner or later than expected, however it provides a solid foundation to my financial decisions. DCA’ing a fixed amount consistently, can capture downturns through larger unit purchasing power during downturns and a lower unit purchase when prices are high.
If you wish to top up at certain points with spare cash you can, but do so with the understanding that things could get a lot worse further down the line. Offloading large amounts of cash indiscriminately into investments during market downturns, is no better than gambling – there’ll be big winners and sore losers.
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