The uncomfortable truth about why market timing simply doesn’t work
And why anyone who tells you otherwise is a liar or an idiot
All the authorless citations in this article are from the book: “The 5 Mistakes Every Investor Makes and How to Avoid Them: Getting Investing Right”
Is market timing possible? The evidence points to no.
But what exactly is market timing? Market timing is trying to make the most out of your investments by entering the market when it’s at the lowest and about to go up, and exiting the market when it’s at the highest and about to go down.
The concept of timing the market is extremely attractive for a large number of investors, especially for those just getting started. Who wouldn’t have wanted to invest at the bottom of the 2008 crisis just before the market went up by 60%? Or take their profits just before the market nosedived?
But the problem is, timing the market consistently is simply not possible.
You might say: if it doesn’t work, why are there so many professional, well-trained, knowledgeable people trying to do it or saying they can do it?
The answer is to earn money. Your money, specifically.
There are three reasons why it’s hard to beat the market.
The market is efficient
You can’t get an edge over other investors because the market is efficient and all information about a company is immediately reflected in its price. (Fama, 1970).
It’s not enough to be right than 50% of the time
In fact, depending on market moves, an investor needs to be right 69 to 91 percent of the time (Sharpe, 1975). Good luck with that!
A study examined over 1 million market timing sequences from 1926 to 1999. The conclusion: holding the market outperformed over 80 percent of market timing strategies (Bauer and Dahlquist 2001, p. 38). That is an overwhelming conclusion and yet we are surrounded by people who tell us that timing the market is possible. Why? Let’s take a look.
Why individual investors get market timing wrong
As the graph below shows, most investors withdraw the money from mutual funds when the market goes down and put it in when the market goes up.
Put another way, they sell when the market is low and buy when the market is up, which is exactly the opposite of what you want to be doing. It’s not logical, but it happens that way for a number of psychological reasons.
Why the media gets market timing wrong
Here are some hilarious examples of the press failing at market timing:
“The Death of Equities.” August 13, 1979, BusinessWeek—just prior to the biggest stock market run-up in history.
“The Crash.…After a wild week on Wall Street, the world is different.” November 11, 1987, Time—the market proceeded to rocket 31 percent over the next 12 months.
“Buy Stocks. No Way!” September 26, 1988, Time—just before the greatest 10-year run in market history.
“Will you be able to retire? With stocks plummeting and corporations in disarray, American’s financial futures are in peril.” July 29, 2002, Time—the market was up 21 percent from July 2002 through June 2003.
The media does not care whether you make money or not. The media cares about drawing eyeballs to their content and getting you to watch their ads and buy their subscriptions.
Why the economists get market timing wrong
“We’ve long felt that the only value of stock forecasters is to make fortune tellers look good.”Warren Buffett
The economy is an extremely complicated system with too many variables. Too complicated for anyone, even the experts, to predict with any sort of sustainable accuracy.
This doesn’t stop the “experts” from making bold predictions about the direction of the market. Here’s a collection of economists getting the market terribly wrong.
Ouch. But there’s more.
The economy often does whatever it wants.
Of course, sometimes an economist makes a prediction that turns out to be correct. For example, there’s Dr. Nouriel Roubini, who correctly predicted the 2008 recession. What you don’t often hear is that he also predicted a recession in 2004 (nope), 2005 (still no), 2006 (no recession) and 2007 (still no recession). Had you listened to his advice, you would have been out of the market during the recession but also for 4 years before. You would have been better off if you hadn’t done anything at all!
“Even a broken clock is right twice a day.”Anonymous
“Joe Stiglitz, a Nobel Prize-winning economist, has said that economists get it right “about 3 or 4 times out of 10” (Weber 2011). With those odds, I’ll pass. You should too.”
Why investment managers get market timing wrong
“Sure it would be great to get out of the stock market at the high and back in at the low, but in 55 years in the business, I not only have never met anybody that knew how to do it, I’ve never met anybody who had met anybody that knew how to do it.”John Bogle, founder of Vanguard
“Man is incapable of understanding any argument that interferes with his revenue.”Descartes
Investment managers salaries depend on convincing you that market timing is possible and that they know how to do it.
The bottom line is that there is an army of investment managers who claim to be able to time the market. Some are famous and some are not, but they all share the same quality: none of them can to this effectively and consistently .
The odds of timing the market consistently over time are extremely low and only a fool would try it. An even bigger fool would pay someone else to gamble with their money this way. The odds are so stacked against the market timer that it’s not even funny.
If you meet an investment manager who claims they can time the market, run away.
Subscription newsletters claiming to provide market timing opportunities are just one more resource investors can use to underperform the stock market.
Most newsletters underperform the market. So how about the ones that outperform it?
Following market timing signals from newsletters lead to underperformance.
I leave you with this pertinent quote:
“The only way to make money with a newsletter is by selling one.”Malcolm Forbes
Why your friends get market timing wrong
There’s always that one guy who says he has this amazing opportunity that you shouldn’t miss out on or that points out his big wins while failing to mention his numerous pass losses.
If even the pros can’t do it, do you really think your friend can? Common sense says no.
Better alternatives to market timing
There is a mountain of evidence against trying to time the market. So how should you invest your money instead?
The Schwab Center for Financial Research evaluated the outcome of five decisions available to an investor who has $2,000 in cash to invest once a year for 20 years (Riepe 2013):
A theoretical “pipe dream” perfect timing strategy would yield the best profit. Since we have seen this is not possible, we need to look at the rest of the options.
Two that have good performance are to invest the money immediately and to use a dollar-cost averaging strategy (a strategy that allows an investor to buy the same dollar amount of an investment at regular intervals.”).
The difference between investing immediately and dollar-cost averaging is often a higher chance of volatility of the first choice. Even though the first option has better performance, some investors might feel better knowing their investment won’t act like a rollercoaster as much.
In any case, both options are better than bad timing, which is what investors will do if they think they can time the market.
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The Oracle of FI is a middle-class guy working as a software developer. His goal is to achieve full financial independence by the age of 40.
He started this blog in 2019 in order to share his tips and techniques on investing, saving money and making the most out of life.
He has a cat and lives in France.