by Carla Lake | August 28, 2013 7:31 am
So you’ve set up your IRA and you’ve picked the stocks, mutual funds or ETFs you want to buy … but when should you buy them?
I was in exactly this situation. I wanted to create a simple stock investing strategy to compound my money. I knew that I didn’t have the time to watch the market constantly, especially after I read Vanguard fund expert Dan Wiener’s advice on trying to time your buys and sells:
Market timing sounds so simple and elegant; however, I think it pays to remember that it takes not one, but two correct market calls to be successful at it. You’ll have to sell before the markets fall and buy before they rebound, which I can almost guarantee they will once the dust settles.
I’ll leave that to the professionals, thank you very much. But how do I know when to buy stocks?
I ran the numbers on a few different stock investing strategies using historical prices over the past five years for the S&P 500 SPDR ETF (SPY).
On paper, this stock investing strategy seems like it’s guaranteed to yield the highest return because you’d ideally be buying when prices are lowest every year, and letting your profits run through bullish trends.
But keep in mind that a strategy like this is easy to produce on paper because in hindsight, we already know when the lowest point was for each year. In the day-to-day, there’s no way you can know if the next day will bring a bull or bear move in the markets, much less whether it’s the top or bottom for the year.
In this hypothetical, the investor buys as many shares of SPY as possible with $2,000 on the first trading day of the year. I didn’t take into account the “change” carrying over from year to year.
This is probably the easiest stock investing strategy for a novice to get accustomed to a disciplined strategy. But it’s not the most lucrative, because by definition, “averaging in” means some months you’ll be buying when prices are overvalued, and some months you’ll be buying a bargain.
This example assumes buying one share of SPY on the open on the first trading day of each month.
This strategy is another that sounds attractive on paper, but is also extremely difficult. Instead of buying the bottom once per year, you would have had to time the bottom 12 times in a year. But if you were successful in this unlikely scenario, here’s what it would have yielded.
Another thing to keep in mind with the frequent buying strategies of Strategy 2 and Strategy 3 is that transaction fees with each trade will cut into your return in a way that they would be less pronounced with the first strategy.
Taking into account a $7.99 fee per trade, here’s how it shakes out:
So the numbers are clear — your returns wouldn’t have been that different if you tried to buy the lows each month or if you simply bought on the first trading day of the month. Strategy 1 would yield the highest return, with or without taking commissions into account.
Is it realistic to expect you can time the lows every month, or even every year? Of course not. But by saving up your money and planning a buy-under price you’re comfortable with, you have a lot more wiggle room to beat the market than you would by buying more frequently.
Carla Lake is an assistant managing editor at Investorplace Media.
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