One of the a prioris to our investing strategy is that market timing simply doesn’t work. The truth is that it does work occasionally but over the long run, it’s virtually impossible to be correct all the time.
Many academic studies have proven that getting in and out of the market on a regular basis results in poor returns. We have included several references to academic studies but a quick search of the web will yield the same results and will likely lead you to the same conclusion as us: Don’t try it and be wary of the person who claims some ability in this regard. As we’ve said before, the vast majority of active equity investors underperform their passive benchmarks. Below are two charts that we feel demonstrate our point:
One reason equity market timing fails is that overall returns for equity markets tend to be disproportionately realized during relatively few days. You miss these few days and your overall return can suffer. (This is both true for good days and bad days in the market, but, market timers tend to be invested for more of the very bad days than they are for the very good days)
S&P500 Returns, 1982-2001
Source: Market Timing versus Dollar-Cost Averaging, Johnson/Krueger
According to an analysis conducted by DUNBAR, a market research firm, timing market entry and exit failed miserably over the 1986-2006 period. The study measured the flow into and out of equity mutual funds among three categories of investors: the average investor, the investor that systematically invests, and the market timer. The results clearly indicated that the average market timer didn’t do all too well…
Source: Bureau of Labor Statistics, DALBAR QAIB 2007, Schwab
Quotes
“Let me be clear on one point: I can’t predict the short-term movements of the stock market. I haven’t the faintest idea as to whether stocks will be higher or lower a month — or a year — from now. What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up.”
- Warren Buffett “New York Times Op-Ed” October 2008
Atlas Capital Advisors LLC note: Believe it or not, there are many people well versed in the mechanics of the market whose last name is NOT ‘Buffet’. Unfortunately, most of them are unknown to the everyday investor.
“There are two kinds of investors, be they large or small: those who don’t know where the market is headed, and those who don’t know that they don’t know. Then again, there is a third type of investor – the investment professional, who indeed knows that he or she doesn’t know, but whose livelihood depends upon appearing to know.”
- William Bernstein “The Intelligent Asset Allocator” 2001
“In the stock market (as in much of life), the beginning of wisdom is admitting your ignorance. One of the many things you cannot know about stocks is exactly when they will up or go down. Over the long term, stocks generally rise at a nice pace. History shows they double in value every seven years or so. But in the short term, stocks are just plain wild. Over periods of days, weeks and months, no one has any idea what they will do. Still, nearly all investors think they are smart enough to divine such short-term movements. This hubris frequently gets them into trouble.”
-James K. Glassman, Co-Author of Dow 36,000, 2001
“Attempting to forecast whether the market is at a peak or in a valley, and whether to buy or unload stocks as a result, is a waste of time. I don’t know anyone who has been right more than once in a row.”
-Peter Lynch, legendary investor and author.
Articles and Research
Black Swans and Market Timing: How Not To Generate Alpha, Javier Estrad, IESE Business School Barcelona Spain, Fall 2008.
Market Timing Doesn’t Work, Liz Ann Sonders, Charles Schwab Chief Investment Strategies, Fall 2007.
Market Timing versus Dollar-cost Averaging: Evidence Based on Two Decades of Standard & Poor’s 500 Index Values, Kim Johnson & Tom Krueger, University of Wisconsin – La Crosse, 2004