The Problem with Thinking You Can Time the Market

Do you – or someone you know – move in and out of investment holdings in order to “boost your return”? If you do, it’s worth considering the downside. Studies consistently show that market timing (you go into investments when they seem good, exit when they don’t) undermines your ability to make investment progress.

Consider the fact that retail (individual) investors typically flee from markets when the bad news already is reflected in prices, and typically try to climb back in when prices already have moved higher. Instead of buying low, selling high, individual investors tend to do the opposite.

I have an excellent graph that illustrates this point – but I’m not able to overcome technical difficulties and print it here (very irritating!)…so I’ll ask you to use your imagination. As you know, the market fell out of bed in September 2008 (good-bye Lehman Brothers, hello imploding mortgage market). The graph I can’t post shows a steady outflow of individual money in mutual funds as the S&P 500 hit bottom (March 2009) and continued to rise into 2011. As the market is rising, individual investors continue to bail out of stocks. 

So who’s driving the market higher? It’s often institutional money (pension funds, professional money managers) who have clients with staying power. This institutional money effectively works to block the natural tendency toward panic selling The proxy for this staying power is Dimensional Fund Advisors but it could be any institutional investor who didn’t try to “market time.” (full disclosure: I use Dimensional Fund Advisors mutual funds for my assets-under-management clients).

Here’s another example of the damage others inflicted on their investment returns when they tried to time markets. Remember the Fidelity Magellan Fund? This fund returned a stellar 29% per year (1977-1990) under Peter Lynch’s tenure but Lynch apparently once said he felt more than half of the Magellan Fund shareholders lost money, based upon fund inflow/outflows. By now you must know the reason why…  Smart money doesn’t exit when the going gets tough – it rides problems out, continues to invest for the future and racks up a better return over time.

About the author

Eve L. Kaplan, CFP®

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