Market Timing Fails As a Money Maker

There are few subjects in the field of investment that are more controversial than market timing. Some people claim it is impossible and others claim they can do it for you perfectly—for a small fee. The truth, however, may lie somewhere between the two extremes.

Key Takeaways

Market timing is not easily achievable.
Over a sustained period of time, almost all investors profit more simply by investing immediately.
Timing the market isn't an illegal practice unless you do so with privileged information.
It is easier to make long-term timing predictions than short-term ones because of large cycles like Presidential elections and interest rate adjustments.
Some market movers know where traders will consider something a good entry or exit point, and exploit that psychological angle. A common example is stop-loss hunting.

Basic Dilemma of Market Timing

Markets move in cycles and there are undoubtedly indicators of various kinds that at least potentially reflect the particular market phase at a given time. However, this does not necessarily mean that one can determine when to get in and out both accurately and consistently.

While some cycles are more easily predicted than others, such as Presidential cycles, others are much more difficult to time. Market cycles can last from weeks to years and will differ between investors. While a real estate investor may be more concerned with periods of decades, a day trader will look at the effect a cycle will have on trading in blocks of hours or even sometimes minutes.

Market timing is difficult because many different investors are using their own strategies and trading on their own time, so to speak. This can cause delays in markets or confusion when an otherwise clear move might present itself and make timing difficult. For example, an interest rate cut may negatively affect banking but could benefit those interested in real estate purchases.

Critics of Market Timing

Critics of market timing contend that it is nearly impossible to time the market successfully compared to staying fully invested over the same period. This basic rejection of timing has also been confirmed by various studies reported in the Financial Analyst Journal, Journal of Financial Research, and other respectable sources such as brokers and portfolio rating agencies like Morningstar.

In 1994, Nobel Memorial Prize winner Paul Samuelson commented in the Journal of Portfolio Management that there are confident investors who move from having almost everything in stocks to the reverse, according to their views of the market. He argued, however, that they do not do better over time than the "cautious chaps" who keep roughly 60% of their money in stocks and the remaining amount in bonds. These investors raise and lower their equity proportions only marginally—there are no big moves in and out.

So what is the solution? A portfolio comprising a manageable number of individual equities purchased and sold for the right financial and economic reasons may be the best way to invest (a total return approach). Such a portfolio is relatively independent of the overall market and no attempt is made to beat a particular index. Even more importantly, this approach does not entail market timing. If you aren't sure how to do this, your broker or financial advisor can usually help you construct a suitable portfolio.

A 2022 test by Charles Schwab compared five investing styles, listed below:

Perfect market timing, investing $2,000 once a year at the lowest point.
Investing $2,000 per year on the first trading day.
Dividing $2,000 into 12 pieces and investing at the beginning of every month.
The opposite of number one, investing $2,000 at the highest point.
Left money in cash only, no investments.

The test found that if you are number one, and have the absolute best and perfect timing, you will come out with the highest returns. However, since that is nearly impossible to time, the descending order in terms of profit (after 20 years) was number two, number three, number four, then number five.

The study shows that if you have perfect timing you will come out ahead, but not by much. Numbers two and three were both within 11% of the perfect market timer. Even the one with bad timing came out with three times the amount after 20 years when compared to number five, who held their money in cash.

The conclusion to be drawn from this study is that while you can come out ahead with perfect timing, almost nobody has perfect timing. Therefore, the best idea for nearly all investors is to invest immediately or dollar-cost average (DCA).

The Supporters

Conversely, the leading German stock picker and market timer, Uwe Lang, claims that when there is danger in the markets, investors should sell out of their equities within two to five days and buy them back when the market starts to rise. Furthermore, Lang calls the buy-and-hold strategy a profit killer. That might be true for someone like Lang or Buffett, but for the majority of investors, such a strategy makes absolute sense.

It is important to remember that someone like Lang is tied to the markets 24/7, and the average investor has a day job and cannot allocate themselves to market studies like a stock picker or fund manager can. As seen above in the Schwab test, you can argue that perfect market timing outperforms and you'd be right, but the opportunity cost is high if you don't nail it.

Generally, those in favor of market timing are those who are in a position to make informed decisions on the markets and may even be market-makers themselves.

Getting the Edge

Investment magazines and internet websites also boast endless claims about market timing benefits. So can investors get this winning edge that will enable them to consistently beat the market? What about all those people out there who offer a remarkable range of methods for market timing? Each claims to have found the solution to the timing problem and provides some sort of evidence of success. They all boast of spectacular returns, often in multiples above the usual market indexes, and report how they predicted various booms and crashes or the meteoric rise and fall of this or that stock.

Despite their claims, the standard wisdom is that such models do not and cannot succeed consistently over time. Certainly, both the claims and the evidence should be interpreted with caution. Some of these models may offer some benefit, but investors need to shop around, get second and even third opinions, and draw their own conclusions. Most importantly, investors must avoid putting all of their money into one approach.

After all, although it is difficult to get the timing right, particularly with each and every swing in the cycle, anybody who looked at the market in 1999 and decided to get out and stay out until 2003, would have done incredibly well. Conversely, some invested heavily during the market run of 2007, only to lose a substantial part of their portfolio when the market crashed.

Striking a Balance

For the skeptics, one safe solution to this totally polarized dilemma is simply to abandon timing altogether and put your money in a tracker, which literally goes up and down with the market. Similarly, most investment funds do more or less the same thing. If you simply leave your money in such funds for long enough, you should do fairly well, given that equity markets generally rise over the long run.

Even if you decide not to try your luck at market timing, you should avoid a totally passive approach to investment. Managing your money actively is not the same as market timing. It is essential to ensure at all times that a portfolio has an appropriate level of risk for your circumstances and preferences. The balance of investments must also be kept up to date, meaning that as asset classes evolve over time, adjustments must be made.

For example, over a boom period for equities, you would need to sell slowly over time to prevent the level of risk of a portfolio from rising. Otherwise, you get what is known as portfolio drift, and more risk than you bargained for. Likewise, if you discover that the investment you were sold in the first place was never right for you, or your circumstances change, you may need to sell out, even if it means taking a loss.

Some professional fund managers also have systems for adjusting portfolios according to market conditions. This is a mechanism that automatically switches the portfolio between equities and fixed-income investments. Robo-advisors do this often and are part of the reason why they are so popular. Such an allocator provides a degree of protection from bear markets while optimizing profits in boom periods. The system is also adjusted according to personal risk profiles and survival analysis.

A commonly repeated axiom is "time in the market beats timing the market," and posits that making regular investment contributions at steady intervals will outperform making large investments at the "perfect" time.

Example of Market Timing

Timing the market with precision is a major challenge, but there are ways to figure out whether one should be going heavier into equities or bonds at a particular point in time. Or even entirely out of one and into the other.

In other words, the approach is to let profits run and minimize losses. They stress that it pays off to risk some losses, but that investors need to get out when the losses are still small. For many investors, this is psychologically very difficult and, as a result, they hang on until there are massive losses. An unemotional, high-tech model can be the best way to make these tough decisions.

Some investment companies will use a model that integrates four key variables: market psychology, interest rates, inflation, and gross national product into the stock market and macroeconomic environments. A decision is then made on this basis.

A study done by Index Fund Advisors shows that by avoiding the biggest market sell-off days over a period of 20 years, you could increase your portfolio's performance by a massive 1,047%. However, in order to achieve that number, you would need to sell exactly the day before a massive down day in the markets, and buy the next day. And you would need to miss the 40 worst days during those 20 years, every single time.

Something else to consider is if you are wrong or just have bad market timing instincts. The same group shows that by missing the best days instead of the worst days, your portfolio would see a loss of 104%. No investor can nail the best day every year and miss the worst.

Advantages and Disadvantages of Market Timing

Market timing tends to have a bad reputation and some evidence suggests that it does not beat a buy-and-hold strategy over time. However, the investment process should always be an active one and investors should not misinterpret the negative research and opinions on market timing as implying that you can just put your money into an acceptable mix of assets and never give it another thought.

Furthermore, intuition, common sense, and a bit of luck may make timing work for you. Just be aware of the dangers, the statistics, and the experiences of all those who have tried and failed. Perhaps you can consider making the majority of your investment portfolio in long-term, buy-and-hold securities, and a small portion where you try to time the market. This gives you some exposure without betting your nest egg on a high or low.

Pros

Feeling of accomplishment
Highest possible returns

Cons

Nearly impossible
Loss of opportunity cost while waiting until the "low"
Lose out on holding benefits like lower taxes and dividends

What Is Market Timing?

Market timing is the act of moving funds around, either by investing more or selling when a downturn is anticipated, based on predictive methods. These methods can be technical or psychological or both, but the key concept of market timing is that an investor attempts to make trades at the exact time a market will turn.

What Are Risks of Market Timing?

The risks of market timing are mainly that an investor will miss out on positive price movement as they wait for that perfect moment, and that oftentimes it is difficult to predict when a market will turn, so they invest at an incorrect time. Over time, almost all studies show that for normal investors, buying and holding yields much higher returns with much lower stress.

Is Market Timing Illegal?

Market timing is simply investing based on readily available knowledge and is certainly legal. However, if you have access to information that is private and you make investments based on this knowledge, you could be found guilty of insider trading.

What Is Mutual Fund Market Timing?

Mutual fund market timing is a unique concept and is discouraged by most investors. Mutual funds will only adjust their price once per day, and investors will trade those adjustments. These are usually small price differences, but investors can leverage heavily and have the possibility of taking home large profits. However, there are fees that cut into those profits, and this is a fairly sophisticated strategy and should not be undertaken by most investors.

The Bottom Line

Most investors are not able to time the market well. Being able to do this depends on a number of factors, one of the most important being the time commitment required. Because the majority of investors are busy with day jobs or other pursuits, they will be happy to know that simply buying indexes or stocks and largely forgetting about them will often yield the highest return.