What Is Market Timing & Does It Work?

Market timing is a strategy many investors use to try and increase their investment portfolio's return. But why is market timing such a bad idea?...
David Roberts
July 7, 2021

You Feel The Need To Act

You have a feeling that something is about to happen, and you know you need to do something with your money before it does. Either the markets are about to fall, and you want to avoid a painful loss; or the next market upswing is right around the corner, and you want to make some profit. Not only that, but folks are out there making a killing, and you want a piece of that action too!

You think that if you can do something now it will improve your financial situation and increase your chances of reaching your savings goals. This is what’s called market timing, and it has always been a terrible idea for investors in general, but even more so for current or future retirees.

Market Timing

Market timing means you move your invested money in and out of the markets or between asset classes in a short-term, predictive manner which you believe will result in profits if prices rise or preservation (protection) if prices fall. Trying to predict pricing movements and acting before they occur is regarded by economists as irrational behavior which often leads to results opposite from those the investor is trying to achieve.

“Since 1994, Dalbar Inc.’s Quantitative Analysis of Investor Behavior (QAIB) has measured the effects of investor decisions to buy, sell and switch into and out of mutual funds over short and long-term time frames. These effects are measured from the perspective of the investor and do not represent the performance of the investments themselves. The results consistently show that the average investor earns less – in many cases, much less – than mutual fund performance reports would suggest.” (Dalbar Inc., “Quantitative Analysis of Investor Behavior”, 2021, p.3)

So Why Do We Do It?

It turns out that our brains are hard-wired to look for a narrative to support our convictions, and we hardly need to look far for that support. Financial analysts and the news media continuously encourage us to do something opportunistic with our money. Friends and family are also quick to supply any hype (or its opposite) we need to work ourselves into a mental or emotional state where we just have to do something – we can’t sit on the sidelines and miss out.

  • “Corporate earnings are down!”
  • “The yield curve is inverted!”
  • “Congress and the Administration are ruining the country!”
  • “We’re coming out of a 20% correction!”
  • “The market has just crossed its 200-day moving average!”
  • “Crypto currency is the opportunity of a lifetime!”

Fear of loss or greed for gain are often driving forces behind our need to try and time the market. Other psychological or emotional factors can include overconfidence, herd mentality, as well as emotional biases.

Psychological Warfare

These will trump logic any day and lead an investor to act against their best interests by trying to time the market.

  • Loss-aversion is a bias in which people tend to strongly prefer avoiding losses as opposed to achieving gains. Over the years, behavioral economists have observed that losses are significantly more powerful than gains for many investors. And they will wait, holding onto a poorly performing investment until it rebounds to its original purchase price (which may never happen), while ignoring better investment opportunities in the meantime. This behavior is contrary to the advice from many wise investors: “Cut your losses and let your profits run.”
  • Overconfidence is a bias in which people have undue faith in their own ability to reason and decide, as well as to make accurate judgments. A person with overconfidence bias believes that their skills are better than most. They take credit for positive results and blame other factors, like the economy, for negative outcomes. Because of their superior skill and ability to take in and apply knowledge, they believe they can control what are known to be random events in the markets.
  • Herd instinct or herd behavior is where an investor’s decisions are minimal or absent, and their behaviors mimic those within a group of influencers. This can make investors feel more comfortable, because their actions are in line with those of their group. We as humans are prone to the herd mentality in many familiar ways: shopping, media consumption, politics, etc. The fear of missing out is often the driving force behind herd instinct, especially in the wake of seemingly good or bad financial news.
  • Risk-Averse bias often causes investors to put more weight on bad news than on good news. Risk-averse investors are more prone to flee to safe, conservative investments – or cash – when the markets are falling or are increasingly volatile. Many of these investors will then miss opportunities during the market rebound for fear the upward direction will reverse after they get back in.

So Why Is Market Timing Such A Bad Idea?

Regardless of its source, by the time you hear the news or read headlines like those mentioned earlier, the information has already been incorporated into market prices. Sure, further movements in the direction the so-called “experts” are predicting may still occur, but the financial markets take in and react to new information very quickly. Price changes occur faster than the average investor can keep up with, let alone react to.

With stale information, along with limited knowledge and expertise, the average investor is particularly vulnerable to buying and selling decisions made at the wrong time, resulting in the opposite of what they are trying to accomplish.

Adding to the risk and difficulty of market timing is the fact that you have to be right twice in order to come out ahead – first, when to get out and second, when to get back in (or vice versa).

It’s just plain wrong that you are led to believe you can successfully time the market.

A better and more logical course of action would be:

Disciplined investing into a portfolio built for your comfort level with risk, as well as your capacity for risk. This will allow you to stay focused and help you capture the market returns you deserve while saving for your ideal retirement.

Sadly, logic will not win this argument for many.

Conclusion

Believe me, I can see the signs too, and I understand how many can feel they just have to do something with their money.

  • Coronavirus and its new strains are still out there and could make a return which would have similar effects on the global markets as in 2020 – maybe longer and more severe.
  • Reddit Speculators and buyers of cryptocurrency are making tons of money, and I know folks would like to be a part of that too.
  • Recent political events and the overall climate in Washington seems worse now than ever. That shouldn’t even possible! Budgets never get balanced, and the National debt just keeps rising and rising.
  • Many forecasters think that stocks are overvalued and are due for a “correction.” If we are in an investment bubble, I understand how folks would want to be out before it bursts.
  • Inflation has been rising, and that’s a negative factor for stocks. Inflation often reduces expectations of corporate earnings growth, putting downward pressure on stock prices since it increases borrowing costs, input costs (materials and labor), and it reduces the standard of living for consumers.

Some behavioral finance experts have rightfully drawn a parallel between making irrational money decisions during periods of uncertainty and driving a car while feeling the symptoms of vertigo. Factors like those mentioned above can spur investors to react haphazardly and in a manner driven by cognitive errors and emotional biases. This poses a real danger for the investor saving for retirement:

You might not reach your retirement goals, because the actions you feel will increase your chances of success backfire.

For future retirees who do not wish to subject their nest egg to that level of risk, timenot timing – has proven to be the best option for many. For further evidence that trying to time the markets to avoid losses or capture gains is a losing strategy, take a look at this great article at the Retirement Researcher.

I hope this information has been helpful for you. I am happy to answer more questions or to help you design a financial plan that will give you the confidence about the future you want.

Working with me is easy:

  1. Schedule a phone call
  2. Get the right financial plan for your situation
  3. Keep your plan on track with ongoing support from me
What Accounts Should You Consider If You Want To Save More?

What Accounts Should You Consider If You Want To Save More?

Investors often ease into their savings strategy with small investments into their 401(k) plans. Later, as their finances allow, they “graduate” into other investment vehicles for their retirement nest eggs, such as IRAs and taxable accounts. As their financial lives become more complex, many investors will ask, “If I have a fixed sum of money to invest every month or every year, what accounts should I consider if I want to save more?”

Will Your Social Security Benefit Be Reduced?

Will Your Social Security Benefit Be Reduced?

Choosing the optimal time to start receiving your Social Security benefit is an important step toward ensuring that your retirement income and savings will last throughout the rest of your life. No one wants to leave benefit dollars on the table due to a poor timing decision, not even those who have adequate savings and pensions and are not relying upon Social Security to fund their retirement. The problem folks are facing, though, is that choosing an optimal time to claim their benefit is neither simple nor straightforward.

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