The 'fear of missing out' and 'fear of topping out' may drive you to make mistakes

It's well-known that all of the stock market's net gain traces to a very small number of days. But few know what to make of this fact.

Consider the 25,853 trading days since the beginning of 1928 (through Aug. 12 of this year). Then take away just 94 of those days - 0.36% of them - in which the S&P 500 (or predecessor index) performed the best and the index's net return is negative. In other words, but for just 94 days since 1928 - fewer than one per year on average - the S&P 500 would be trading for less today than it was on the first day of 1928 - 17.76 instead of around 7,800 currently.

Financial advisers say there's been a recent uptick in the number of their clients asking about the stock market's heavy reliance on just a few trading days with outsized returns. Sam Stovall, chief of investment strategy at CFRA, suspects the uptick is due to the repeated success in recent months of "buy the dip" strategies. In an email, he said that this has led the "'fear of missing out' $(FOMO)$ proponents to repeat the mantra" that missing the best days causes a huge decline in long-term returns.

That's not the whole story, as Stovall was quick to point out. Those who have FOMO have another mantra, constantly reminding us that if we avoid just a small number of the worst days, the stock market's long-term return is much, much higher.

The accompanying chart puts these two fears in perspective. The green columns plot what your return would be if you missed the indicated number of best days, while the red columns plot what your return would be if you missed the corresponding number of worst days.

Particularly revealing are the blue columns, which show what your return would have been if you missed both the indicated number of best days and that same number of worst days. Notice that the net effect is that your overall return is almost identical to buying and holding. This means that if you have no better than random success at picking the best and worst days, you shouldn't bother.

Can market timing beat random?

The obvious follow-up question is whether stock market timers can do better than random - successfully identifying when these best and worst days are most likely to occur. To find out, I analyzed my auditing firm's database of stock market timers back to 1980.

The results are not encouraging. Consider the timers' recommended equity-exposure levels for the 50 best and 50 worst days since 1980. On average, their exposure level was higher on the worst days than on the best days - just the opposite of what you would see if timers had better-than-random ability to identify the best and worst days.

This is not as damning a result as it otherwise might seem. According to research conducted by Brad Cornell, who was a professor emeritus of financial economics at UCLA's Anderson Graduate School of Management, the majority of the market's biggest one-day spikes occurred during bear markets. So the market timers' lower average equity-exposure levels during the market's best days may simply reflect the bear markets in which those days frequently occur.

Nevertheless, notice what Cornell's research implies for those who fantasize about being in the stock market on these best days: You need to be heavily invested during bear markets. That's a high price to pay for the once-in-a-year chance of capturing one of those spectacular one-day wonders.

-Mark Hulbert