According to a 2015 study, 33% of investors either did not earn a return or lost money in the market the previous year. The market wasn’t to blame. While the S&P 500 had a 13.5% return in 2014, the median investor earned just 4.2%. The performance gap is often attributed to imprudent actions taken by individual investors.
A prime example is market timing. It is the buying or selling of an asset class based on a prediction of future price movements. In the world of investing, market timing is like a siren call.
You may remember the lovely Sirens from reading Homer’s The Odyssey in literature class. To evade their seductive call, the story’s hero, Odysseus, plugs his men’s ears with beeswax.
It’s easy to fall victim to the allure of market timing. Many investors do it unintentionally, as an emotional reaction to the latest headlines and recent market events. They may flee the market in fear of severe decline, and then become greedy after a string of market highs.
For the average investor market timing is a losing strategy that will take you off course from your financial goals. Here’s why:
It’s extremely difficult
With all due respect to palm readers and astrologists reading this, you can’t accurately predict the future. That’s what makes market timing an unwinnable game. For market timing to pay off, you have to be right twice: sell at the top and buy at the bottom. Further, you need to have the emotional fortitude to buy or sell when most investors are likely doing the opposite.
As if your odds couldn’t be any worse, you also have to essentially compete with professionals who are bolstered by extensive research and high-powered technology. It is likely the information you’re acting on is already reflected in market prices, effectively eliminating any potential opportunity to benefit.
It leads to poor performance
As mentioned above, investor behavior is typically detrimental to performance. In a study published by the Journal of Finance, researchers showed that the more individual investors traded the more their performance suffered.
Investors who attempt to time the market tend to do so at the wrong time. They get out at the bottom and jump back in at the top. Poor timing, of course, means poor performance.
Each year, the biggest market rallies and declines usually happen on just handful of trading days. A study by University of Michigan Professor H. Nejat Seyhun found that just 90 days generated 95% of all markets gains over a 30-year period, from 1963 to 1993. That’s an average of three days per year. Missing out on only few trading days can have a major impact on performance.
It’ll likely cost you
Market timing can cost you in more ways than one. You are charged trading fees and possibly commissions when you buy and sell investments. If you sell on a downswing, you’ll lock in your losses. Finally, depending on the type of account, you could accumulate taxes.
If you feel the desire to get out of the market for a while, stop and ask yourself if you have legitimate reasons to make changes to your portfolio. Has anything in your life affected your financial circumstances or goals?
If not, it’s better to follow the lead of Odysseus and stay the course. When you have a long-term focus, it’s not about timing the market but rather time in the market. Sticking with your plan can increase the likelihood of attaining the wealth you need to realize your goals without the risk from all the guesswork.
That’s why we recommend taking the emotion out of investing. We offer portfolios that are designed to match an investor’s need for growth and tolerance for risk.