Does market timing ever pay?

Looking back at the steep market plunge in 2016, when stocks lost more than 15 percent of their value in less than 10 days, it was reported that over $80 billion of small investor dollars flowed out of equity mutual funds. Since then, the stock market has been on an incessant climb to record highs; yet only a fraction of that $80 billion has found its way back into the market.  It is but one more clear indication that investors who try to time the market nearly always miss the mark.

Very few people, if any, can consistently predict changes in market direction. No one was prepared for the crash of 2008 which is why crashes happen. Precipitous drops in the market happen unexpectedly, which is why they usually trigger panic selling and small investors get trampled in the stampede.  When the stock market recovers, most investors wait to see if it will be a sustained recovery or a “sucker” rally. 

The dirty secret among professional investors is that when small investors panic and exit the market, it’s time to buy, and when the small investor re-enters the market, it’s time to sell. Yet, there are still a number of investors who hold onto the notion that they can call the shift and make the right move at the right time.

While it may not be impossible to time the market, few investors are able to so with enough consistency to gain any real advantage over buy-and-hold investors. According to Morningstar, the return generated by active funds that moved in and out of the stock market between 2004 and 2014 was 1.5% less than passive funds. In fact, to gain any real advantage over passive funds, active fund managers would have to make the right move 70% of the time, which is nearly impossible over a 10-year period.


The real cost of market timing

Aside from the fact your investment costs increase when you enter and exit the market – trading costs, commissions, taxes (on gains) – your investment performance is more likely to suffer. Consider investment period 1996 to 2015. According to Morningstar, if you remained invested in the S&P 500 for the full period, you would have earned an annualized return of 8.2%. However, if you missed the 10 best days of the market your return would have been cut in half to 4%. If you happened to miss the 20 best days, your return would have been halved again to 2%. If you missed 40 of the best days, you would have had lost 2%.


Can the potential gains ever be worth the real costs?

We will probably never admit it, but most of us are lousy timers; and of course none of us can predict the future. How many times have you try to shift your way through stop and go freeway traffic only to end up in the slowest lane? For investors, the real costs of lost time and opportunity are almost always greater than the potential benefit of shifting in and out of the market.  We would all be served well by heeding Warren Buffet’s observation that “A prediction about the direction of the stock market tells you nothing about where stocks are headed, but a whole lot about the person doing the prediction.” 

Vitali Butbaev