In 2024, a Significant Blunder in the Stock Market Proved Expensive for Investors. Here's What Market Participants Need to Understand for 2025.
Mainstream media often talks about the stock market with a short-term perspective. Worse still, they advocate for market-timing approaches. These experts draw random lines on charts to signal when to buy or sell, making it sound highly intellectual. However, the facts are evident: Market-timing strategies often lead to failure.
Goldman Sachs analysts studied the performance of the S&P 500 (^GSPC -0.70%) in the first 10 months of 2024 and concluded, "Investors might want to wait for a better entry point, but the potential benefits of investing, even at an unfavorable time, surpasses the drawbacks of not investing at all."
The importance of staying in the market rather than trying to time it can't be overstated. In fact, one of the major mistakes investors could have made in 2024 was staying away from the market entirely. Check out more details below.
Skipping the stock market in 2024 resulted in significant losses
Although valuations were high throughout 2024, investors who steered clear of the stock market probably incurred significant penalties. Consider three hypothetical portfolios with money invested in an S&P 500 index fund. All began with $10,000 at the start of the year, but their strategies varied thereafter.
- Portfolio 1: The investor never added money due to valuation concerns and awaited a better buying opportunity.
- Portfolio 2: The investor added $1,000 each month, purchasing shares at the bottom each time.
- Portfolio 3: The investor added $1,000 each month, acquiring shares at the highest point each time.
It's easy to assume Portfolio 2 performed best because of perfect timing. Conversely, it's simple to believe Portfolio 3 performed worst due to the worst possible timing. However, only one assumption is correct. Below are the hypothetical portfolio values 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)
Avoiding the stock market in 2024 could have been extremely costly. Portfolio 2 is worth $585 more than Portfolio 3, demonstrating that perfect timing only provided a marginal improvement over the worst possible timing. But both outperformed Portfolio 1. The investor in Portfolio 1 made about half as much profit as the other two due to continually waiting for a better opportunity.
Bears may seem intelligent when explaining why the stock market is ripe for a reduction, but trying to predict a market reduction is an excellent way to miss out on gains. Legendary investor Peter Lynch once advised that "far more money has been lost by investors preparing for corrections, or trying to predict corrections, than has been lost in corrections themselves."
In a nutshell, it usually makes more sense to keep investing during the good times and the bad. Stock market corrections are unavoidable, but trying to predict those corrections often results in losses. Moreover, the S&P 500 has rebounded from every correction in history, and the market generally rises more than it falls.
The S&P 500 is historically costly heading into 2025
As of Dec. 20, the S&P 500 had a forward P/E ratio of 22.2, according to Yardeni Research. This is higher than the five-year average of 19.7 times forward earnings and the 10-year average of 18.1 times forward earnings. In actuality, the index hasn't traded at such an exorbitant valuation since April 2021, according to FactSet Research.
Since 1980, the S&P 500's forward P/E ratio has exceeded 22 only during two periods: (1) the dot-com bubble in the late 1990s and (2) the stock market surge following the outbreak of the COVID-19 pandemic in 2020. The S&P 500 plummeted sharply in both instances.
So, on one hand, history indicates skipping the stock market can be a seemingly costly mistake. But on the other hand, history also suggests forward P/E multiples above 22 are eventually followed by a reduction or bear market. Investors can resolve these conflicting data points by adjusting their strategy in 2025.
Specifically, anyone purchasing individual stocks should pay particularly close attention to valuations. Many stocks are currently overvalued, and the fear of missing out is not a valid reason to buy. Instead, seek out stocks trading at reasonable prices and limit your purchases.
Alternatively, anyone purchasing an S&P 500 index fund should invest more gradually. If you usually invest $400 every month, consider reducing that figure to $200 each month. Keep the extra money in your portfolio. That way, when the next reduction comes around, you'll be able to profit from it.
Investing wisely in finance can yield significant returns, even in unfavorable market conditions. Goldman Sachs analysts emphasized that, despite high valuations in 2024, potential gains from investing outweighed the drawbacks of missing out entirely.
Accordingly, it's essential to allocate funds towards investing regularly, rather than waiting for the perfect market entry. As demonstrated in the hypothetical portfolios, perfect timing only provided a marginal improvement over the worst possible timing, yet both outperformed a portfolio that never added funds due to valuation concerns.
