Market timing for fun and profit! Now that sounds good, right? Who wouldn’t want to have fun while making a profit? In the investment world, that’s the siren song of the market timer. They ask the obvious question, “Why would you want to invest in the market when it’s going down?” Of course no one would.
See Also: The World’s Greatest Stocks
As a consequence, there is an overwhelming temptation to follow the guru who promises to help you avoid bear markets by trying to ride market updrafts and avoid drops. That approach of beating the market is an overwhelming temptation for many investors.
A simple analysis of market history would show that if you called the market correctly every year you’d be rich. If you were correct in calling the market even half the time, your return wouldn’t be too bad, either. Given those odds, why wouldn’t you give market timing a shot?
Advertisement
The problem is that, as in many cases, simple statistics can be very misleading—like the stories of the man who drowned in a lake with an average depth of 3 feet, or the man who thought he’d be comfortable with his head in an oven and his rear in the refrigerator.
Assuming returns based on the concept of flipping a coin can be very misleading. What matters is the actual annual sequence of returns. Remember, a market timer has to be right twice – when to get out AND when to get back in. Consider the following example:
The timer correctly called the bull markets in years 1 and 2 but missed the first bad market in year 3. He then redeemed himself by calling the serious bear markets in years 4 and 5, avoiding a 35% loss. Unfortunately, while waiting for confirmation that the market had turned, he missed the dramatic bull markets in years 6 and 7 (remember, you have to decide when to get back in as well as when to get out). The result: Patient investor, 4.6% annual return; Timer, 3.9%.
How likely is it that this will happen to a market timer? Over time, it’s just about guaranteed. Consider the grand recession. From November ‘07 to March ‘09, the market fell 46.7%. The subsequent one-year return was 53.6%!
Advertisement
Still not convinced? If I asked you to name the top 10 artists of all time or the top 10 baseball players or the top 10 presidents, we’d all have our own list and happily debate our choices. Now, let me ask you, name the top 10 market timers of all time? Having trouble? How about the top 5? Still stuck? How about the top 1? I’m sure you’re still having trouble.
My point is, if anyone had successfully timed the market over an extended period of time we would know his or her name as they would be one of the richest people in the world. The fact that we don’t know any names should be a warning sign not to chase the illusion of market timing.
Research has shown that when you factor in transaction costs you would have to be correct almost 70% of the time. And that assumes instantaneous switching from stock to cash and back. The real world doesn’t work that way. If you factor in a time delay for switching to look for a market “confirmation,” you would have to be correct almost all of the time to beat the buy-and-manage alternative.
The moral? If you want to make money in the market, you have to be in the market – all of the time.
Advertisement
See Also: 12 Stocks to Earn Dividends Every Month
Harold Evensky, CFP is Chairman of Evensky & Katz, a fee-only wealth management firm and Professor of Practice at Texas Tech University. He holds degrees from Cornell University. Evensky served on the national IAFP Board, Chair of the TIAA-CREF Institute Advisor Board, Chair of the CFP Board of Governors and the International CFP Council. Evensky is author of The New Wealth Management and co-editor of The Investment Think Tank and Retirement Income Redesigned.
Comments are suppressed in compliance with industry guidelines. Click here to learn more and read more articles from the author.
This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.
Source: Kiplinger
The Folly of Market Timing
