Market timing seems so easy, in theory. Buy when prices are low and sell when they are at a high. Anyone who diligently follows the market and stays abreast of economic news can anticipate, and capitalize of these movements, right?
Wrong, at least not over the long term. As history has shown repeatedly, market timing is a losing game. Volumes of research critical of the practice have been written, and some of the greatest investment minds – William Sharpe, a Nobel laureate, Benjamin Graham, considered the father of value investing and John Bogle, founder of The Vanguard Group – have all counseled against it.
Experts are right a fraction of the time
Even so-called market timing experts can’t consistently predict when to move in and out of the market. A study by CXO Advisory Group tracked more than 4,500 forecasts by 28 self-described market timers, between 2000 and 2012. Only 10 were able to accurately forecast equity returns (as measured by the S&P 500®) over 50% of the time, and none were able to predict accurately enough to outperform the market.1
Certainly, some investors have made accurate market calls, and others have predicted a market bottom or top. But over the long run, the law of averages usually wins out, effectively rendering a market timing strategy a game of chance.
As difficult as market timing is for professional investors, they are typically guided by a buy and sell discipline. Nonprofessional, individual investors tend to sell in a panic at or near a bottom, and buy in a flush of confidence at or close to a market top. Behaviors such as loss aversion, overconfidence, anchoring and avoidance often overtake rational decision making, resulting in losses.
Market timing your way out of money
Perhaps the most significant deterrent to market timing is the cost of being out of the market. For example, the chart that follows shows the effect of missing the 12 top-performing months for stocks (as measured by the S&P 500®) during the 10-, 20-, and 30-year periods ended September 30, 2014. Investors who remained invested for the entire period would have achieved higher returns for each holding period than those who tried to time the market and missed.2
1Index Fund Advisors, Inc. (IFA.com), 2014. Based on a study by CXO Advisory, copyright: CXO Advisory Group LLC. http://www.ifa.com/12steps/step4.
2Source: Wealth Management Systems Inc. For the period from October 1, 1984, through September 30, 2014. Based on the total returns of the S&P 500® index. Copyright © 2015, Wealth Management Systems Inc. All rights reserved. Not responsible for any errors or omissions.
The S&P 500® is a market-value-weighted index of 500 large capitalization stocks traded on the NYSE, AMEX and NASDAQ. Past performance is not a guarantee of future results. For illustrative purposes only and does not reflect any specific product. Index returns assume reinvestment of dividends and do not reflect any fees or expenses. Indexes are unmanaged and it is not possible to invest directly in an index.
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Article by Wealth Management Systems Inc. and provided courtesy of Morgan Stanley Financial Advisor.
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