Why Market Timing Is Risky Business

Few words characterize today’s financial markets like uncertainty. When the federal government can be switched off like a light, and speeches by Federal Reserve officials cause markets to flip-flop unpredictably, investors are left wondering what they should do. In an attempt to make major market movements work for their portfolios rather than against, some investors attempt to time the market.

Market timing is basically the strategy of trying to predict future market movements in order to time buying and selling decisions. When markets are rallying or pulling back, it can be very tempting to try and seek out the top to sell or the bottom to buy. The problem is that investors usually guess wrong, missing out on the best market plays. Does the cost of trying to time the market make a big difference in your returns?

Missing out on the market’s top-performing days can be costly. This chart illustrates how a hypothetical $10,000 investment in the S&P 500 could have been affected by missing the best days during the 20-year period between January 1, 1993 and December 31, 2012. This is a simple example that leaves out some important elements like transaction costs but it serves as a useful illustration of our point. Investors who remained invested for the entire period could have seen their investment grow to $51,404; those who missed just the five top days would have accumulated just $34,113; investors who missed out on the best 30 days would have gained around $600 during the whole period.

Source: Standard & Poor’s. Stocks are represented by the S&P 500, an unmanaged index generally considered to be representative of the U.S. stock market. Past performance is not a guarantee of future results. This is a hypothetical example used for illustrative purposes only and excludes important factors like transaction costs and management fees. You cannot invest directly in an index.

Investors are notoriously bad at picking the right time to enter or exit investments; by the time an opportunity is on their radar, the “smart money” is usually nearly ready to get out. The problem is that the majority of equity gains are made in a very short amount of time. If you’re not in the stock when it moves, you may miss out on the whole play. Oftentimes, good and bad days in the market can come very close together, making timing an even trickier proposition.

Bottom line: It’s virtually impossible to accurately find the top or bottom of the market consistently. Our experience shows that time in the market is more important than timing the market. Does that mean that investors have to passively wait out every market, hoping that the next big decline doesn’t take out their life savings? Definitely not.

There’s a big difference between trying to time markets and making strategic shifts to try and avoid major market declines. One of the benefits of active management is that, rather than relying on a single strategy, investors can tap into the experience of multiple money managers who employ different market strategies. Active managers rely on analytical research, economic forecasts, and the human elements of experience and intuition to make critical investment decisions. Now, that’s not to say that even the best managers don’t have bad years. Whatever investment strategy you choose, it’s impossible to perfectly predict future market movements.

Conclusions

Long experience has taught us that successful investing requires discipline and the patient execution of a long-term strategy, most especially when it is emotionally difficult; in fact, that is usually the time when opportunities are greatest. We understand that market timing has a tempting simplicity to it – buy low and sell high. However, it’s pretty hard to correctly predict the tops and bottoms of markets and most investors get it wrong. Remember, you don’t have to be the first to the party or the last to leave to have fun – often, just being there when it matters is enough to help you achieve your financial goals.

If you have any questions about the information we’ve presented or want to know how recent economic events may affect your investments, please let us know; we would be happy to discuss your concerns.

Disclosures:
Investing involves risk including the potential loss of principal. No investment strategy can guarantee a profit or protect against loss in periods of declining values.