Perfect Timing Less Vital Than Plain Time

Indeed, academic studies have shown that the bulk of your returns over time depend on the general asset classes you own. The individual investment within that asset class--a specific mutual fund, for example--matters far less in the long run. Ditto for market timing decisions.

Consider data from a study by the Schwab Center for Investment Research in San Francisco. It examined the fates of five hypothetical investors, each of whom was given a $2,000 bonus at the end of each year between 1979 and 1998, for investment in the following year.

The first investor has "perfect timing": He puts his money to work in a Standard & Poor's 500 stock index fund at the exact lowest point in the market the following year. While he's waiting, he parks the money in 30-day Treasury bills.

The second investor puts the money into the S&P immediately.

The third investor dollar-cost averages--in other words, he divides his $2,000 into 12 equal parts, and invests one-twelfth in the S&P each month.

The fourth investor has the absolute worst timing, investing in the S&P at the absolute highest point in the market the following year.

The fifth investors plays it safe by leaving the money in 30-day T-bills.

Not surprisingly, the "perfect timer" made the most money after 20 years. Based on the market's performance from 1980 to 1999, this person walked away with $387,120 in 20 years' time.

Yet the person who invested immediately at the end of each year still came away with $362,185--only about 6% less than the perfect timer.

The dollar-cost average ended with $352,450, or about 9% less than the perfect timer.

The big surprise, says Mark Riepe, who heads the Schwab center, was that even the person with the worst market timing made $321,569, or just 17% less than the perfect timer.

Similar results were found on a rolling 20-year basis going back to 1926. It just goes to show you that time really is on your side--even if you're not the best investor.

While their elders fret about the details of proper asset allocation and how much to emphasize capital preservation over capital appreciation, many 20- and 30-something investors understand this principle and believe they just need to follow a simple rule.

"The basic underlying lesson is just to be invested,'' says Jay Paul Reddy, a 19-year-old junior at Texas Tech University.

If the stock market produces lower returns over the next 10 years than over the previous 10 years--a good possibility, given the dramatic gains in the '90s, many experts say--that may well be a problem for a 50-year-old investor who was counting on a hot market to secure his retirement at age 60.

But a 30-year-old investor doesn't face that kind of ticking clock. He or she can be patient.

What's more, while an older investor must factor in the risk that the market could be depressed for many years--it has happened before, after all, such as in the 1970s--a younger investor can be comforted by this fact: A diversified portfolio of U.S. stocks has never lost ground in any 20-year period, notes Mark Riepe, who heads the Schwab Center for Investment Research in San Francisco.

Stocks pay off in the long run for a simple reason: When you own stocks, you own a piece of the economy. As the economy grows long-term, stocks are the easiest way for most people to cash in on that growth.

Odd as it may sound, younger investors may even want to root for a severe bear market that pulls stock prices lower. Why? That would mean more opportunities to buy good stocks at cheaper prices, potentially enhancing long-term returns.

For most 20- and 30-somethings, following a few basic investing rules at this stage of life should turn out to be highly rewarding later on:

Stick with stocks.

If interest rates go up and stock returns down, some younger investors may be thinking of shifting a chunk of their long-term savings to bonds or money market accounts.

Don't, experts say.

Let's say that over long periods the stock market reverts to its historical performance of annual returns averaging in the 10% range. Let's also assume that long-term bonds, which have historically returned about 5.5% a year, do better than that--more like in the 7% range.

Are 3 extra points worth the risk of owning stocks? You bet. If you invest $10,000 for 30 years, you'll end up with $76,100 at a 7% annual rate of return. But $10,000 invested for 30 years at a 10% annual rate of return will turn into $174,500.

Mike Scarborough, president of the Scarborough Group, an Annapolis, Md.-based 401(k) investment management firm, is one of many financial planners who think 20-somethings and even many 30-somethings don't need any fixed-income investments.

That's especially true if you work for a company that provides a traditional defined-benefit pension. "If you know you're going to receive that defined benefit, and if you know on top of that that you'll receive Social Security, those are effectively bond-like assets'' to include in your long-term savings calculations, he says.

But Scarborough and other advisors caution that their all-stock advice for younger investors applies only to true long-term savings, such as for retirement.

"If you're in your 20s and saving up to buy a house, that's different," says Sheldon Jacobs, editor of the the No-Load Fund Investor newsletter.

Money you're saving for expenses you expect in the next few years shouldn't be in the stock market, many pros say. A money market fund would be a safer place.

Take some basic diversification steps.

Dividing your stock investments among a few basic categories, such as large and small stocks, and U.S. and foreign stocks, is a way to ensure against calamity in any one sector.

Brad Rumble, an L.A. teacher, learned to invest in the go-go tech market of the '90s. Now he's thinking about diversifying his portfolio.

"I made big bets on technology and basically won them,'' says Rumble, a teacher at Rosemont Elementary in downtown Los Angeles. "But I think it's really important not to be seduced by those gains."

He's looking to increase his stake in foreign stocks and non-tech sectors.

Likewise, Todd Lucas realizes he has nearly 60% of his money tied up in technology with his current portfolio. He's now looking for a less-racy blue chip fund, perhaps one that gives him more exposure to so-called value stocks.

His goal: "Fewer ulcers" as the market does whatever it does.

If you're young, don't sweat the idea of having the "right" diversification, experts say. Try a mix of funds that you think suits you. You have the luxury of experimenting--and it's a good way to learn about the market.

Maximize your tax-deferred retirement accounts.

"This is a no-brainer, especially if there's a match [contribution]" from your employer, says Rande Spiegelman, manager of KPMG's personal financial planning services in San Francisco.

"Tax-deferred compounding is too awesome to skip," Spiegelman says.

Yet only half of all 20-somethings who are eligible to contribute to a 401(k) retirement plan actually do, according to a recent survey by Fidelity Investments.

Worse still, only 6% of 20-somethings who described themselves in the survey as "beginners" at investing are contributing the maximum that their companies and/or the IRS allow. Even among the self-described "self-starters" only 32% are maxing out their contributions.

This may explain why the average 401(k) account balance for a 20-something is just $8,000.

Of course, many younger people have bills to pay, precluding saving as much as they can in their retirement plans.

But remember: Failing to take full advantage of these plans means you're leaving money on the table. If your company contributes 50 cents for every $1 you contribute, that's an automatic 50% return on your investment--with absolutely no risk.

But it's not just the match. "The most powerful dollars you can invest are pre-tax dollars," Rumble notes. For instance, if you're in the 28% federal marginal tax bracket, all it really costs to save $1 in a retirement account is 72 cents, because that money otherwise would be taxed.

If your company offers, say, a 50% match, it really costs only 72 cents to save $1.50.

Being a teacher, Rumble is ineligible for a 401(k). But he can contribute to a self-directed, tax-deferred 403(b) plan. Rumble manages to stuff the maximum allowed into his plan. "Then I look to other options," he says.

Dollar-cost average.

This means putting the same dollar amount into the market every month or quarter. So you're buying more shares if the market sinks, and fewer shares as it rises.

By investing in a 401(k) or 403(b), you are already dollar-cost averaging. But there's a case to be made for dollar-cost averaging in investments outside your retirement accounts, as well: It's a way to be a disciplined investor, and to avoid the temptation of trying to time the market.

Which gets us back to square one: The only real stock market risk that 20- and 30-somethings face in the long run is the risk of not being in the market at all.