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…The trouble with market timing is that in order to win, you must correctly predict market
cycles. How do you know when to sell an asset class? You don’t have a crystal ball, so you can’t possibly know the correct answer. Do you sell now? Next week? Next month?
The original article has been edited here for length (…) and clarity ([ ])
Let’s say you do end up correctly guessing when to sell. You’re still only halfway there because you now have to figure out when to get back in. For example, if the market drops 600 points in a day, is that when you will dive back in? Or will you wait for a full month of terrible returns and, if you do, and then buy back in and the market continues to fall, will you bail again?
If you do happen to successfully time both sides of the market – which, again, is a rare occurrence indeed – it’s not necessarily a given that you will have made any money. After all, if your gains are relatively modest, then the cost of trading in and out of the market may eat up most of your profits.
Time in the Market vs. Timing the Market
Take for example a story of three friends: Laurie, Angela and Karen are old college friends who began investing in 1987, each with $100,000.
- Karen has invested her $100,000 in four installments, each one timed at the top of a bull market. She waits until the market is “good” before investing and she never sells.
- Angela is great at recognizing the bottom of a bear market, and has also invested her $100,000 in four installments – each one made right at a market bottom.
- Laurie never pays much attention to what the market does on any given day. She invested her $100,000 in one lump sum and hasn’t done anything with it since.
Laurie got into the market of the fall of 1987, right before the “Black Monday” crash, which meant her portfolio’s value was cut by more than 30% in her first few months, leaving her far “behind” her two friends but, when the three of them looked at the larger, long-term picture, it was a different story. Laurie – who never watched or timed anything – is now well ahead of her friends.
(Click on image to enlarge)
Market Return Source: CBOE daily; S&P 500® (SPXSM) Price Return 8/25/1987 to 5/31/1988, and S&P 500®. Total Return (SPXTR) inclusive of dividend reinvestment 6/1/1988 to 12/31/2015. Note: 1% flat annualized return used for uninvested cash in the above hypothetical scenario. This example is fictional and does not depict any actual person or event.
The moral of the story? Invest assets in the market as soon as you are able. Yes, there will be ups and downs, but as long as the world economy continues to improve living standards, investors will be rewarded with compounding growth on their investments. Even supernatural timing of market bottoms doesn’t beat time in the market.
Conclusion
Staying focused on a long-term plan with clear goals is the best way to navigate what can sometimes be an emotional roller coaster. The market is, after all, rarely driven by just one factor – that’s why it’s so hard to time the ups and downs. Investors with a strategic plan can feel more confident about their finances and don’t have to worry about outguessing factors beyond their control.
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