How to Make Money in the Stock Market

Words of wisdom from Peter Lynch:

“The real key to making money in stocks is not to get scared out of them.”

-Peter Lynch

And if you don’t trust Peter’s judgment, consider this…

From 1982 to 2001, the S&P 500 gained a 11.8% per year. Had you invested $10, 000 at the beginning of this timeframe, you’d have $93, 075 if you keep your nerve through the ups and downs and stayed in the market. In contrast, these are the returns if you jumped in and out and even slightly mis-timed the sometimes dramatic recoveries from the bottom:

If you missed the 10 best days, you’d have $56, 044
If you missed the 30 best days, you’d have $28, 144
If you missed the 50 best days, you’d have $15, 780

Considering that there are roughly 250 trading days in a year, this means that missing out on the best 0.02% of the investing days over this 20 year period (i.e., the best 10 of 5000 days) would’ve reduced your total return by nearly 40%! In contrast, if you’d sat tight throughout, you’d be sitting pretty right now.

And keep in mind that this time frame extends halfway into the 2000-2002 burst of the dot com bubble, and also includes the Black Monday crash of 1987 when the Dow Jones Industrial Average dropped by nearly 23% in a single day. Thus, while it covers and overall strong period for stocks, it’s not an especially atypical timeframe.

See also: How to Make Money in the Stock Market (Revisited)

[Source: “The Best Investment Advice of All Time” by Carla Fried, Money Magazine]

22 Responses to “How to Make Money in the Stock Market”

  1. Anonymous

    I wrote the post Jonathan referred to in comment #19. If you think it was a *huge* oversimplification, I’d like to see how *huge* you think the oversimplification was. If I give up a factor of a billion, the odds are still *huge* against missing the 10 best days. Under what assumptions can you get the odds of missing the 10 best days up from one in 2.8 billion billion billion to say one in 1 billion? Even then, is it worth talking about a one in a billion event?

  2. Jonathan, while that post is correct that this overstates the problem in that people won’t miss just the 10 best days of the market, it completely ignores that fact that the biggest days often come in the earliest stages of a recovery.

    For example, looking over the past 25 years, three of the 10 biggest days came in the week and a half following Black Monday, and two more of them occur in close succession at the very tail end of the dot bomb debacle. Thus, these days are concentrated into periods when people are especially likely to have bailed on the market and not gotten back in.

    Consider the scenario in which sometimes gets smacked on Black Monday, jumps out of the market to lick their wounds, and then immediately misses gains of 9.3%, 5.3% and 4.9%. They’ve now locked in a huge loss that they had little chance of avoiding in the first place, and they also missed out on a huge recovery.

    Calculating the probability that people will randomly miss the ten best days is a *huge* oversimplification, and it casts doubt on the entire argument.

    If you haven’t seen it yet, I’ve written a followup analysis that talks about some of these things, and also expands the dataset.

  3. Anonymous

    I love that data! It really shows us how you can’t time the market and you need to stay invested for the long haul.

    But it also makes you wonder what the returns would be if you had missed some of the down days of a bear market.

  4. Anonymous

    This is a very simple quote and some may even find it funny, but it is so true. Peter Lynch certainly understands how the market works, and individual investors that listen to him should do well.

  5. Anonymous

    Lol, we are having the same thoughts. I wrote a post yesterday about missing the biggest days in the stock market, and I included Peter Lynch’s quote as well.

    Must be due to the bad advice about getting out of the market until you feel confident again.

  6. Anonymous

    Hey Nickel, I’d love to see a post expanding on the point you made in comment #7… that is, that many of the big-advance days are just after a fall or correction in the market.

    That would really put the last pig in the barn for me… because I might be able to get out of the market, but I’d probably be still licking my wounds and unable to get back in when the market is at bottom. I think this is the biggest psychological problem of timing the market, knowing when to get back in.

    And your post illustrates it nicely!

  7. Anonymous

    This reminds me of a chat I had at lunch about the lottery. You’ll never win it if you don’t bother getting in.

    There may be bad days, but they are balanced by the good days, so either way, a person ought to get into saving and investing.

    I’m all about down markets like this one because it means that there will up days later. Might not be a week from now, but inexorably they will arrive.

  8. Anonymous

    Like I said, no advocacy of market timing here. Get in for the long haul, and be smart about where you put your money so that it reflects aversion to bad risk (like sub prime lending) and attraction to good risk. Keep your money in the market and you will get 10-11% in the long haul. Figure out ways to minimize your losses during the bad days, and maximize the profits in the good days, and you will eek out an extra 1-2%. For most the added time spent doing that will not be worth the minimal added reward. For me, I enjoy managing it on a weekly/daily basis, and I don’t mind spending the extra time. Only time will tell if it was worth it.

  9. Mike: True. This misses out a 22% (not 25%) loss in 2002, but it includes a 9% loss in 2000 as well as a 12% loss in 2001, and it also includes the dark days of 1987.

    You are, of course, right in that a big challenge is getting people to think 20 years down the road.

  10. Raz: The challenge is to consistently be “scared at the right time,” and to likewise get your courage back at the exact right moment. Do you think you can consistently do this over the long haul? If so, there are an awful lot of mutual funds out there that would love to hire you.

  11. Raz: That’s a valid point, except that it’s virtually impossible to predict with any sort of accuracy when those bad days will be, in the same sense that you can’t predict when the good days will be. The fact of the matter is that the stock market has an overall upward trajectory. Thus, the good days will outweigh the bad days.

    As it turns out, the upward moves often come in strong (but short) bursts that are incredibly easy to miss. In fact, these are often concentrated in the early stages of recoveries, before the typical investors knows what’s going on. Thus, the deck is stacked against you if you jump out of the market and then try to go back in once things are looking brighter — more often than not, you’ll have already missed the biggest before you get back in.

  12. Anonymous

    Like I said I’m no advocate of market timing. I sat through the decline, took my lumps, and am now seeing the rewards of my patience with the market. However, I had a hunch at about 13,800 in the dow that things were about to turn sour. The amount of money that I moved out of what I felt were risky investments saved me a lot of losses. I took losses, but not like I might have. I’m now in position to use that money to buy even more after the decline. To an extent I was a scared investor, but I was scared at the right time, not when it was too late. I guess the point that I wasn’t making very well before, is that I’d rater miss a couple good days running up to the 23% decline day, than be in the market when the crash comes.

  13. Anonymous

    Mike, that is a phenomenon that hurts Americans in all walks of life– the inability to think about the future. People would rather consume now than delay gratification, and this is a killer in personal finance and retirement planning. I’m just a year older than your brother and have run the numbers . . . if I don’t think about 20+ years NOW, I’ll have to work 10x harder to catch up later. Keep working on your brother, and maybe he’ll come around.

  14. Anonymous

    I noticed that the statistics conveniently ignore the stock market implosion where the S&P dropped 25% in 2002. And the problem with long-term thinking is that it’s pretty darn hard to get people to think 20 years in the future. I’ve had this conversation with my brother (27) and he just isn’t interested in thinking that far out. This is especially true when they have a vague remembrance of the dot-bomb years. That’s why the people who are willing to stick it out will get the >10% return.

  15. Anonymous

    Raz, that is true except doesn’t really apply to the “scared-investor” phenomenon we are concerned about: The market drops, the scared investor pulls out, and then the market continues as it always has. The scared investor by definition was in the market during the “worst” day but has a good chance of also missing the “best” day. Instead, a steady investor endures the worst and benefits from the best; in the end, the best comes out on top.

  16. Anonymous

    This statistic always bugs me. By no means would i advocate timing the market, but if you’re gonna bring up statistics like that you need to show the flip side. What would your return be if you were out of the market for the 10, 20, 50 WORST days over that time period. Lets say for instance. If I had taken my money out on Jan 1 of this year, and kept it out until Aug 14, I would have missed a hug run up of the S&P to 1550, but I would have also missed the sharp decline. In fact I’d be even money just like everyone else. If you are going to highlight what you miss by doing that, also point out what you gained.

  17. Anonymous

    Wow. Very good point: we endure the really bad days without selling because we never know when the really good days will come–but they always come and are always better than the bad days are bad.

    This is also true in poker: it is better to stick around and win a few big pots than to “strike when its hot” and win a bunch of little pots, when you have a good hand. However, in poker, you have to be well above average skill to win money; in the stock market, you just have to be lazy.

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