Market Timing: Brilliant Strategy or Losing Game?

It is safe to say that investing is hard. And because of that, there is an urge and temptation to seek new strategies to maximize returns.

One of the strategies that you might be lured to is market timing.

Market timing involves attempting to predict the future movements of financial markets in order to make timely investment decisions. In this post, I'll delve into what market timing is and examine the evidence surrounding its effectiveness.

Understanding Market Timing:

At its core, market timing is the art of determining the optimal moments to enter or exit the market, or switch between different investments.

The idea is that if you can correctly time when to make investment changes or enter/exit the market altogether, then you stand to profit from greater returns compared to simply staying invested. A successful market timer would buy low and sell high, then repeat over and over.

This strategy relies on various indicators, technical analysis, and economic data to make predictions about the future direction of asset prices. Proponents argue that successful market timing can lead to higher returns compared to a passive buy-and-hold strategy.

Evidence for Market Timing:

So, now understanding what market timing is, it is worth examining if it works. Further, if it works, can you reasonably expect to sustain such a strategy for a long period of time? All investing strategies must be capable of withstanding the long-term to truly build a portfolio that can meet your objectives.

I can admit the concept of market timing is intriguing. Who wouldn’t want the opportunity to increase returns by simply making a few well-timed trades? But the evidence supporting its effectiveness is mixed.

Numerous studies and research have attempted to assess the viability of market timing as an investment strategy. Some argue that successfully timing the market consistently is exceedingly difficult, if not impossible, due to the unpredictable nature of market movements.

Good news sometimes means the market goes up...but sometimes it goes down. Bad news sometimes means the market goes up...but sometimes goes down. The point is that it is very, very difficult to predict which way the market will move in the short term.

Take 2023 for example. A recent article published on November 8, 2023 highlighted the number of up vs down days for the S&P 500. As of that date, the index was up 113 days and down 102 days. Nearly a coin toss. Yet, the market was up 14% year to date. So if it is nearly a coin toss whether the market will go up or down on a daily basis, how do you make sure to get it right?

Charles Schwab (and others) have performed an analysis around 5 different investing styles. The full article is here, but I’ll summarize it now.

The strategy revolves around 5 different strategies (illustrated through 5 different people) investing $2,000 per year for 20 years into the S&P 500. The 5 people are:

1. Peter Perfect - every year he invested $2,000 at the market’s lowest point for that year
2. Ashley Action - put $2,000 into the market on the first trading day of the year
3. Matthew Monthly - he took the $2,000 and divided it into 12 equal portions, and invested those portions at the beginning of each month
4. Rosie Rotten - had terrible luck, as she put her $2,000 into the market at the peak of every year
5. Larry Linger - he left his $2,000 in cash (T-bills) every year. He never got around to investing because he was convinced that better investing opportunities were just around the corner

So who won? Well Peter Perfect did as that is an incredible skill. But in my opinion, look at how close Ashley Action and Matthew Monthly followed behind. The difference, after twenty years, is not that large considering Peter got the best day to invest right every single year.

Remember, Peter Perfect got the bottom of the market right for 20 years...that is going to be completely impossible to put into practice.

Other considerations:

Numerous trades may incur transaction costs and frequently buying and selling can erode returns through fees and capital gains taxes being triggered. Beware of the potential tax effect of making any transactions.

Additionally, markets can be influenced by unexpected events, making accurate predictions challenging. Factors such as geopolitical events, economic shocks, or unforeseen market sentiment can quickly alter the trajectory of asset prices.

There’s a better way!

Let me be clear - I completely understand the desire to try and market time, as well as the challenge of investing large lump sums of money at once.

Working with clients, we try to dig into the perils of market timing and whether it is truly feasible or not. With the evidence against you for market timing, we can use other systematic approaches to take the stress out of needing to obsessively monitor when best to buy and sell.

Instead, I believe in setting an investment strategy based on your asset allocation and portfolio that is suitable for the long term. Create a portfolio that manages risk and uses a strategy that you can stick with through various market conditions. This is different for everyone, but is much more simple and more effective for truly building wealth.

Conclusion

Market timing remains a topic of considerable debate in the financial community. While the allure of outsmarting the market is tempting, the evidence suggests that successful and consistent market timing is challenging to achieve.

Next time you have that money to invest or are fighting the temptation to make changes to your portfolio, think about whether it is the right idea to get your hands on your portfolio, or if you would be better off sticking to your strategy.

Remember - you only know the worst day of the year - in other words the best day to invest - in hindsight once the year is over. You won’t know it at the time.