Why Trying To Time The Market Is A Painful Strategy
What's the secret to becoming wealthy in the stock market?
Some people say the key to success lies in timing the market – investing only when the stock market is at its lowest, selling when it reaches its peak, and then repeating this cycle over and over again.
Fortunately, that's just not true! In fact — if we're being completely candid — it's an awful strategy, and you will almost certainly end up losing money instead of making it. While in theory, this strategy sounds great. It’s incredibly difficult and impossible to do over and over again.
Here’s why timing the market doesn’t work as a strategy for building wealth over time.
What Does "Timing the Market" Mean?
Timing the market means making decisions about when to buy or sell investments based on predictions about how the market will move in the future.
Some people try to time the market by waiting for a particular event, such as high unemployment or an increase in interest rates, before they make an investment decision. On paper, this strategy looks great. In real life, however, trying to time the market comes with many risks. For one, attempting to predict what might happen and when, is generally a fool's game. Or as Yogi Berra used to say, "It's tough to make predictions, especially about the future." Only God knows what is to come.
In order to time the market successfully, you need to know when to get out and when to get back in. That means you have to successfully predict the future not once but twice.
Moreover, there can be costs associated with entering and exiting trades that have relatively short durations like a few days or weeks. These costs can add up over time, which can make timing the market more costly.
According to research from Ramsey Solutions, "Investments held for 30 years average 12% annual growth. Timing the market can reduce returns by more than 7%."
Has Anyone Successfully Timed the Market?
If you're thinking about trying to time the market, know that you're not alone—lots of people have tried (and most have failed). In fact, there's no clear evidence that anyone has been able to do it successfully on a consistent basis. While being right feels great, it’s the other five to ten times when you’re wrong that you need to worry about. Standard and Poor’s conducts a study each year which has consistently found that most professional active money managers who are trying to beat the market - fail.
That doesn't stop some investors from trying. Consider this case scenario:
Let's say you invested $1 in the stock market way back in 1930. You would have lost 42 cents the first year, which is a bummer. But wait! You'd have bounced back. The market was up 35% in the 1940s, 257% in the 1950s, and 54% in the 1960s. In fact, the only decade in which you would have lost money is the 2000s. Today, your $1 investment in 1930 would have turned into $5,223.83 — if you never touched it. That's a gain of 9.7% per year or 522,282.57%. What about inflation? Even when accounting for inflation, you'd still have a 6.34% rate of return.
What if you did touch it, though? Let's say you timed the market to perfection — never buying higher than the lowest day or selling at the highest day — you would earn returns at 3,793,787%.
Impressive? Sure, but you're never going to time the market perfectly. What if you made just one error? What if, just one time, you bought too late or sold too early? You could take a major hit! The stock market needs 1,100 days on average to fully recover after a visit to bear market territory. Basically, just one or two errors and you could have locked in your losses for a very long time.
Timing the market is often referred to as an art form, and historically, timing strategy rates have not outperformed buy-and-hold investing. What this means is that if you could invest your money for ten years and make 10% per year by picking the right stocks at just the right time, but then lose 20% in one year because you picked stocks at the wrong time, you would end up with less money than if you had simply stuck with your initial investment plan.
What Typically Happens When You Try to Time the Market
Why is timing the market bad? First of all, it's difficult to predict when the market will rise or fall. Even if you think you have a good handle on things, you could be wrong. And even if you're right, there's no guarantee that you'll be able to sell at the perfect time.
Five things that can happen when you try to time the market:
You miss out on potential gains if you had otherwise stayed in the market.
You increase your transaction costs by buying and selling more often.
You may pay higher taxes if you realize short-term gains.
You increase your risk of making emotionally-driven decisions.
The top CEO or political figure tweets something, and there goes the market. - short-term the markets often react to the daily news.
Investing Isn’t About Timing the market, anyway
While many people may want to believe investing is about timing the market, we know that's not the case. Instead, investing is about putting your money into assets that will grow over time.
More specifically, you want to design a well-diversified investment strategy that provides a long-term return for the amount of risk that you are comfortable taking. If you can do this consistently, rebalancing accordingly, and stay invested for long periods of time, then history would say you will be able to build up wealth without having to worry too much about timing the market.
No investment strategy ever studied beats consistency and self-discipline.
Timing the Market vs Time in the Market
"Buy low, sell high" is popular financial advice. Like many popular maxims, though, it's easy to repeat and not always easy to do. A better mantra might be "spend time in the market instead of trying to time the market." Maybe the line is not as punchy, but the advice is worth a lot more.
In a 2012 study, Charles Schwab found that between the years 1926 and 2011, a 20-year holding period never produced a negative return. It’s not without it’s ups and downs, but over time the stock market as a whole has continued to go up. If you can just stay in the market over time, then you can let the market work for you. In 2021, Schwab performed a different test. This time, they investigated five investment styles, including buy-and-hold and timing-the-market approaches.
They found that an investor with absolutely perfect market timing — a skill about as likely as never missing the right number on the roulette wheel — would only outperform a buy-and-hold investor by about 11%. If I have $2,000,000 invested, that’s roughly $200k more for accomplishing the impossible and for the stress and anxiety that inevitably came along with it.
So in other words, buying a good asset and holding on to it leaves you almost as wealthy as if you had bought at the lowest and sold at the highest every single time you invested in the market — a feat no investor to date has accomplished.
If the academic research is right, the key to winning with investments is to play the long game, not to focus on buying low and selling high. Let go of conventional wisdom and embrace the sedate world of more passive investing. You might just come out a lot richer for it.
Keys to Successful Investing
If "buy low, sell high" isn't a viable strategy — and on it’s own, it's not — then what does it take to create wealth using the stock market?
Have a plan and stick to it. A good plan includes your goals, your level of risk tolerance, and a timeline for achieving what you want to accomplish.
Keep emotions out of the equation. Emotional investing is a major reason people stumble in their investment journey. They watch the market, get nervous (or greedy), and make premature decisions.
Diversify your portfolio. Diversification modifies risk. Ecclesiastes 11:2 says, "Invest in seven ventures, yes, in eight; you do not know what disaster may come upon the land."
Don't try to time the market. Buy your investments carefully, and then (generally speaking) plan to be invested for at least 3-5 years. Ideally, longer, and you’ll just watch them grow.
Stay disciplined with your investing strategy. A decent plan consistently followed is better than an amazing plan that sits on the shelf. Stick to your diversified strategy, which likely requires investing new funds accordingly and rebalancing along the way.
Review your portfolio regularly. You should receive regular updates about your portfolio's performance from your financial advisor, and when things change they should be there to help you make adjustments accordingly.
Have realistic expectations. Investing is not a get-rich-quick scheme. It's a consistent, disciplined approach to building wealth. Proverbs 28:20 reminds us, “A faithful person will be richly blessed, but one eager to get rich will not go unpunished.”
FAQs About Timing the Market
What is timing the market? Timing the market refers to trying to predict when the stock market will rise or fall in order to buy or sell stocks at the right time.
Why is timing the market a bad idea? Many investors believe that timing the market is a losing strategy because it's impossible to consistently predict short-term movements in the stock market. Some studies have found that Conventional investment strategies — such as buying mutual funds through automated dollar cost averaging and under the direction of an advisor — have consistently paid the biggest dividends.
What are some of the risks of timing the market? The risks associated with timing the market include missing out on gains when the market rises and buying high when the market falls.
How can I avoid timing the market? Determine your goals. Then, work with a qualified investment advisor to create a responsible, actionable financial plan. If watching the stock market's gyrations bothers you, then turn off the TV, surf away from the financial news sites, and ignore the daily banter on the news. You'll be happier, and your portfolio will be healthier.
To discover what strategy works best for your financial goals, contact Cooke Wealth Management. We would love to talk with you.