What is market timing?
Market timing is the attempt to be fully invested when the market rises and not exposed when it falls. A more subdued strategy would avoid the all-or-nothing approach and revolve around a central asset allocation percentage; stocks would be over-weighted and under-weighted in anticipation of bull and bear markets, respectively. Basically, buy low and sell high. You do not have to find winners; you simply have to be invested at the right time.
Why you should avoid market timing
Most news leads us to bad timing
Anyone can look back in time, plot market levels and see ‘lost’ opportunities of buying in the valleys and selling near the peaks. Unfortunately, those valleys mark times when news is generally horrible and the world seems doomed to enter depression. Conversely, the peaks usually coincide with glowing news of profits, productivity and the promise of even better things to come. Unless you are completely oblivious to current events in general and business news in particular, you will be encouraged to buy and sell at the worst times.
There is no useful predictor of market turns
Every morning, analysts on business channels predict if the market will rise or fall during the trading day. These one-day prognosticators are wrong as often as they are right. The fact is: no one can know what the market will do next; this is true about tomorrow, next month, next year and beyond. Despite ads and brags to the contrary, no system predicting tops and bottoms actually works. If it did, computer programs would already be utilizing it and the owners wouldn’t be telling you about it.
Missing only a few days of an upturn destroys results
Many people who try to time markets have invested at what looked like bottoms only to discover they bought near the top of a much bigger decline. More commonly, timers often hold back on buying stocks, waiting for a dip of some sort, only to miss out on most of the appreciation. Fact is, many of the market’s best days come right after a trough when the world looks most bleak. Over the 50 years 1968 through 2017, there were over 12,000 trading days during which the S&P 500 had an average annual return of 10.05%. Excluding only the best 50 days of that period, the average annual return for all 50 years drops more than half to 4.8%.
In dollar terms, the impact of lost opportunity is more dramatic. $10,000 invested in the S&P 500 at the beginning of 1968 and not touched for 50 years thereafter would have grown to about $1.2 million. If you missed only the best ten days of over 12,000 trading days, the ending balance would have been less than $600,000 instead. If you missed the best 50 days, you would have ended up with about $103,000.
Professional market timers do poorly
To succeed at market timing, guessing correctly more than half the time is not good enough. This is because you have stunted your returns during those times you are wrong, as cash is not as profitable as stocks in an up market. Research shows you must be right about 74% of the time to match the returns of a buy and hold strategy.
In a survey by CXO Advisory Group of Manassas, Virginia covering 68 professional timers from 2005 through 2012, only one firm hit the 70% success rate. Another study by the same group analyzing over 3,500 predictions by 34 firms from 2000 through 2012 found no firms did better than a 67% rate while 22 of the 34 were under 50%. Separately, Professors John Graham at the University of Utah and Campbell Harvey at Duke University looked at over 15,000 timing predictions by 237 newsletters from 1980 to 1992. The results of these newsletters were poor enough to drive 94% of them out of business during the period. These stats refer to professionals. What are your odds?
What you should do instead
Do not try to time the markets. If you have not already done so, evaluate your tolerance for risk and determine your appropriate target asset allocation. Regardless of what you think about market tops and bottoms, you should bring your equity exposure toward your target allocation.
If you have no stock exposure at this point and are hesitant to jump in fully, pick a date within a year to achieve a fully invested position. Count the months between now and the date chosen. Divide the amount of money you will allocate to stocks by the number of months. Invest this dollar amount each month. If the market falls, you will buy at better prices. If it rises, what you already bought will have done well.
Know there will be ups and downs. You will save time and gain value not trying to predict when they occur.
* Data sources:
S&P Dow Jones Indices LLC; Standard & Poor’s 500 Index, CXO Advisory Group, LLC
John Graham and Campbell Harvey, “Market Timing Ability and Volatility Implied in Investment Newsletters’ Asset Allocation Recommendations,” Journal of Financial Economics, vol. 42, no. 3 (1996)