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Why Market Timing Doesn't Work

Personal Finance Investments

We very rarely receive calls from clients who want to jump in and out of the market, or even in and out of asset classes. Actually, we typically get calls from media outlets when markets are rocky! But we do think it is worthwhile to provide you with an explanation of why that is. It is always good to understand why you are invested the way you are, especially since market timing is a popular (and misguided) theme in financial media ahead of this election, as it is before all national elections. It doesn’t hurt to have a reason for raising an eyebrow at that one acquaintance or family member who wants to tell you all about how he’s selling to cash until after November 8.

It’s an awkward situation. What do you say? Never fear—Halpern Financial is here with a few ideas.

Why Market Timing Doesn’t Work

The simple answer: You have to be right twice.

Not only do you have to buy at the right time, you have to sell at the right time. Even professional fund managers are not good at this, and research has shown that market timers even underperform a  random coin flip!

photo by Simply CVR  (CC BY-ND 2.0)

The same is true if you’re worried about a potential upcoming drop in the market. You have to sell at the right time, and then get back into the market at the right time. If you’re already nervous, at what point will you regain the confidence to invest? It may feel safer to just be out of the market completely during volatile times, but the longer you are in cash, the larger your risk of not achieving your financial goals. J.P. Morgan’s 2015 Guide to Retirement shows that missing the 10 best days of the market can reduce your performance by over a third.

The snooty answer: The Nobel Prize-award-winning Efficient Markets Theory states that the market knows more than you do.

Our portfolio strategy is informed by economist Eugene Fama’s Nobel Prize-award-winning research on Modern Portfolio Theory and efficient markets. The Efficient Markets Theory proposes that the prices of all stocks and bonds reflect all the information currently available. In the internet age this is especially true, with high-frequency algorithms trading billions of dollars in response to various triggers like news, earning reports, and movements of stocks in the same industry faster than a human ever could. You can argue whether this is good or bad for individual investors, but it definitely makes markets extremely efficient. That means you really don’t stand a chance of trying to trade to take advantage of an underpriced or overpriced stock or asset class. All of the facts currently available to investors are already “baked in” to the price.

The “cold, hard facts” answer: People don’t outperform the index (at least, not consistently over long periods of time).

Maybe you’ve done the research, run complex algorithms, and figured out a trading strategy bound to be profitable. Maybe you have information no one else knows, and you’re positive that your stock or chosen asset class is about to skyrocket (by the way, that’s completely illegal if it’s insider information from your company).  Maybe you’re just taking a gamble. No matter what your reason for trying to time the market, the numbers are against you—even a cat randomly picking stocks might outperform you.

  • According to Dalbar’s research, every year, the average investor underperforms the indexes, and a major reason is market timing. In 2015, the 20-year annualized S&P return was 8.19% while the 20-year annualized return for the average equity mutual fund investor was only 4.67%, a gap of 3.52%.
  • Last year’s top-performing stock of the S&P 500 (up 134.4% in 2015) has plummeted down from #1 to #458, and is down -14% so far this year.  Studies have repeatedly shown that it is impossible to be profitable on a consistent basis with a market-timing strategy that relies on picking winners and losers from year to year. (BTN Research)
  • With better information, investors are abandoning funds that rely on stock-picking strategies. Prior to the internet, it was difficult to compare fund performance—but now with a click of the mouse, investors can easily see how unsuccessful active managers are at beating their indexes. An incredible 96% of actively managed mutual funds fail to beat the market over any sustained period of time. The odds are stacked against professionals too—the chance of winning at Black Jack when you “hit” on two face cards is twice as good (8%) as the chance of beating the market (4%).

What does contribute to long-term investment success?

 In every past quarter and in every quarter to come, we practice portfolio and financial planning strategies that are proven by research rather than trying to time the fickle and unpredictable moves of the market.

  • Regular rebalancing: Rebalancing is the only way to improve your probability of consistently buying low and selling high. However, it feels very counterintuitive to buy “losers” and sell “winners,” so very few individual investors actually do rebalance.
  • Tax efficiency: Our portfolios for tax-deferred and after-tax accounts are designed to ensure that various investments are in the correct type of account to limit taxes. In addition to the broad portfolio design, we take tax efficiency into account on a variety of levels, taking specific investments, cash flow needs, and the individual’s tax situation into account with every move we make within the portfolios. This includes holding the right securities in the right type of accounts, and monitoring the tax implications of gains against losses.
  • Low institutional costs. The funds and ETFs we select for our portfolio have extremely low expense ratios, which keeps more money “in your pocket” to grow through the power of compounding. Because of our size and institutional access, we are also able to trade free of cost, and we only use products free from commissions and other hidden fees.

In the current environment of slow growth and low yields, it is very tempting for investors to seek outperformance however they can. Market timing is one of the common temptations, but don’t let yourself be swayed from your diversified portfolio strategy! It’s the most efficient path to achieve your investment goals.

IMPORTANT DISCLOSURE INFORMATION

 

Please remember that past performance may not be indicative of future results.  Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Halpern Financial, Inc.), or any non-investment related content, made reference to directly or indirectly in this blog will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful.  Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions.  Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from Halpern Financial, Inc.  To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. Halpern Financial, Inc. is neither a law firm nor a certified public accounting firm and no portion of the blog content should be construed as legal or accounting advice. A copy of the Halpern Financial, Inc.’s current written disclosure statement discussing our advisory services and fees is available for review upon request. Please Note: Halpern Financial, Inc. does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to Halpern Financial, Inc.’s web site or incorporated herein, and takes no responsibility therefore.  All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly.

 

 


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