Miss How Many Months? How many of the best (or worst) months you will miss in this scenario.
Time Period: The number of years of stock market history you want to consider. For most people, the best timeframe to consider would be the number of years till retirement. This lets you see the advantages or disadvantages of taking a more aggressive approach or a more hands-off approach.
Timing the Market
The market has highs and lows. Historically, a very large amount of the money made in the stock market is made at the very highest points. Likewise, the lowest points account for a very large proportion of the money that is lost. That's why the traditional market advice is "buy low, sell high." That is, you should get in before the market goes high in time to enjoy the high, then get out while it's still high in order to avoid losing money in the low time. Unfortunately, people who do not understand the "buy low, sell high" concept will be attracted at the high moments and put off at the low moments. That's why day-trading (amateur buying and selling of stocks without paid advice) is often so disastrous. If you knew exactly when it was still a good time to buy, and exactly when you had to sell, you would be extremely rich.
Market Highs and Lows
We all know about the bad times. The most dramatic of these bad times are stock market crashes. Most famous was the stock market crash of October 24, 1929, an important factor in the Great Depression. October 19, 1987, "Black Monday," was another infamous stock market crash, even bigger by many counts than the 1929 crash. More recently, in the years 2000 and 2001, the stock market dropped dramatically, particularly among technology stocks.
The good times are almost as famous. In the late 1920s, stocks for new-fangled companies like General Motors sent the markets soaring, just as Yahoo! did in the late 1990s.
The other financial markets, such as the bond markets, are less flashy, but they also have their highs and lows. Still, since stocks are, on the whole, the biggest money-makers, they tend to drive the markets and attract the most attention.
Everyone knows the market has highs and lows. But no one knows when exactly the highs and lows will come. Each day is a new day and at any given moment the markets may go down or up. Anyone who claims to know the exact moment when the market will peak or bottom out is lying--otherwise they would be profiting from the knowledge instead of spreading it around.
The Law of Averages
The good news is that over time, the highs have outweighed the lows. If you had bought General Motors stock in 1927, only to see it lose most of its value in 1929, you would have gotten your money back and then some if you held onto it into the boom years of the 1950s.
So, if you "stay invested," holding onto your investments, the odds are good that you will make money over the long haul, especially if your investments are well diversified. If you had held that General Motors stock from the 1960s till today, you would have lost your shirt all over again. But presumably you would have invested at least some of the earnings from the boom years into other stocks that might turn out to be an IBM or Dell Computer. Diversification is an important part of ensuring the law of averages works for you. By diversifying your investments--investing in more than one thing--you reduce the risk that one or two big investments will sour and wipe you out.
Of course, if you do manage to buy low and sell high even a few times, you will be far ahead. In the short term, you risk losing a lot of money. But over the long term, the odds get better and better that you will come out well in the end. That is because on average the markets' highs gain more than the markets' lows lose. So if you play the market, over time your wins will likely outweigh your losses. But the less time you have, the less you should play, since you won't have enough time to make up for any losses. In general, if you are investing to retire in your seventies, it makes more sense to try to play the market in your thirties than in your fifties.