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!

The num­bers

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.

The uncomfortable truth about why market timing simply doesn’t work

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.

On octo­ber 15, 1929, Irv­ing Fish­er, whom Mil­ton Fried­man declared the “great­est econ­o­mist the unit­ed states has ever pro­duced,” assert­ed that “stock prices have reached what looks like a per­ma­nent­ly high plateau.” the fol­low­ing week, the mar­ket crashed, tak­ing us into the great depres­sion and begin­ning a free fall that would even­tu­al­ly see the dow lose 88 per­cent of its val­ue.

Ouch. But there’s more.

On jan­u­ary 10 2008, Ben Bernanke stat­ed: “the fed­er­al reserve is cur­rent­ly not fore­cast­ing a recession.”9 unfor­tu­nate­ly, the econ­o­my did­n’t lis­ten, as a few months lat­er the econ­o­my slid into the worst reces­sion since the great depres­sion, tak­ing the stock mar­ket down more than 50 per­cent along the way.

The econ­o­my often does what­ev­er it wants.

In his 2006 book, The Next Great Bub­ble Boom, Dent wrote, “The Dow Jones Indus­tri­al Aver­age could reach as high as 35,000 or 40,000 by late 2008 or 2009…. This con­tin­ues to be our fore­cast…” (Dent 2006, p. 44). Of course, we all know that the mar­ket fell into free fall in what turned out to be the great­est pull­back since the Great Depres­sion, bot­tom­ing in March of 2009

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.

Why newsletters get market timing wrong

Sub­scrip­tion newslet­ters claim­ing to pro­vide mar­ket tim­ing oppor­tu­ni­ties are just one more resource investors can use to under­per­form the stock mar­ket.

In 1994, John Gra­ham and Camp­bell Har­vey, ana­lyz­ing data pro­vid­ed by Mark Hulbert,15 con­duct­ed what many con­sid­er the most com­pre­hen­sive study on the abil­i­ty of newslet­ters to pre­dict the mar­ket (Gra­ham and Har­vey 1994). They looked at over 15,000 mar­ket tim­ing calls from 237 newslet­ters over 13 years. The con­clu­sion was over­whelm­ing: 75 per­cent of the newslet­ters pro­duced neg­a­tive abnor­mal returns. Basi­cal­ly, fol­low­ing the advice of most of these let­ters cre­at­ed neg­a­tive per­for­mance!”

Most newslet­ters under­per­form the mar­ket. So how about the ones that out­per­form it?

Mark Hul­bert’s own research shows that the few that do out­per­form the mar­ket in any giv­en year are not the same in future years (Snider 2014). In oth­er words, a good year has no pre­dic­tive val­ue look­ing for­ward. His data on mar­ket tim­ing let­ters specif­i­cal­ly pro­vides an even more dis­mal out­look: His data shows that not a sin­gle mar­ket tim­ing newslet­ter has beat­en the mar­ket over the long run (Snider 2014)!”

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

—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 uncomfortable truth about why market timing simply doesn’t work - recommendation for investing successfully

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