We very rarely receive calls from clients who want to jump in and out of the market, or even in and out of asset classes. Actually, we typically get calls from media outlets when markets are rocky. Unfortunately, advice to buy this or sell that in response to various news events is all too common in financial media, but it is not a strategy that works for most people. Let's understand why. (For related reading, see: 5 Ways to Make Good Automatic Financial Decisions.)
Why Market Timing Doesn’t Work
You have to be right twice. Not only do you have to buy at the right time, you have to sell at the right time. Even professional fund managers are not good at this, and research has shown that market timers even underperform a random coin flip!
The same is true if you’re worried about a potential upcoming drop in the market. You have to sell at the right time and then get back into the market at the right time. If you’re already nervous, at what point will you regain the confidence to invest? It may feel safer to just be out of the market completely during volatile times, but the longer you are in cash, the larger your risk of not achieving your financial goals. J.P. Morgan’s 2015 Guide to Retirement shows that missing the 10 best days of the market can reduce your performance by over a third.
The Market Knows More Than You Do
Our portfolio strategy is informed by economist Eugene Fama’s Nobel Prize-award-winning research on Modern Portfolio Theory and efficient markets. The Efficient Markets Theory proposes that the prices of all stocks and bonds reflect all the information currently available. In this digital age these ideas seem especially true, with high-frequency algorithms trading billions of dollars in response to various triggers like news, earning reports, and movements of stocks in the same industry faster than a human ever could.
You can argue whether this is good or bad for individual investors, but it definitely makes markets extremely efficient. That means you really don’t stand a chance of trying to trade to take advantage of an underpriced or overpriced stock or asset class. All of the facts currently available to investors are already baked into the price. (For related reading, see: 5 Tax Tasks to Complete by the End of This Year.)
People Don’t Outperform the Index
Maybe you’ve done the research, run complex algorithms, and figured out a trading strategy that is bound to be profitable. Maybe you have information no one else knows, and you’re positive that your stock or chosen asset class is about to skyrocket (by the way, that’s completely illegal if it’s insider information from your company). Maybe you’re just taking a gamble. No matter what your reason for trying to time the market, the numbers are against you—even a cat randomly picking stocks might outperform you.
- According to Dalbar’s research, every year the average investor underperforms the indexes—and a major reason is market timing. In 2015, the 20-year annualized S&P return was 8.19% while the 20-year annualized return for the average equity mutual fund investor was only 4.67%, a gap of 3.52%.
- Last year’s top-performing stock of the S&P 500 (up 134.4% in 2015) has plummeted from No. 1 to No. 458, and is down 14% so far this year. Studies have repeatedly shown that it is impossible to be profitable on a consistent basis with a market-timing strategy that relies on picking winners and losers from year to year. (BTN Research)
- With better information, investors are abandoning funds that rely on stock-picking strategies. Prior to the internet, it was difficult to compare fund performance—but now with a click of the mouse, investors can easily see how unsuccessful active managers are at beating their indexes. An incredible 96% of actively-managed mutual funds fail to beat the market over any sustained period of time. The odds are stacked against professionals too—the chance of winning at blackjack when you hit on two face cards is twice as good (8%) as the chance of beating the market (4%).
What Contributes to Long-Term Investment Success?
In every past quarter and in every quarter to come, we prefer portfolio and financial planning strategies that are proven by research rather than trying to time the fickle and unpredictable moves of the market.
- Regular rebalancing. Rebalancing is the only way to improve your probability of consistently buying low and selling high. However, it feels very counterintuitive to buy losers and sell winners, so very few individual investors actually do rebalance.
- Tax efficiency. This includes holding the right securities in the right type of accounts, monitoring the tax implications of gains against losses, and taking specific investments, cash flow needs, and your individual tax situation into account with every move within the portfolios.
- Low costs. Choosing funds and ETFs with low expense ratios keeps more money in your pocket to grow through the power of compounding. Avoiding products with commissions and other hidden fees is another way to keep more money in your account for the future.
In the current environment of slow growth and low yields, it is very tempting for investors to seek outperformance however they can. Market timing is one of the common temptations, but don’t let yourself be swayed from your diversified portfolio strategy! It’s the most efficient path to achieve your investment goals. (For related reading, see: 5 Easy Financial Steps to Take Before the Year Ends.)
Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Halpern Financial, Inc.), or any non-investment related content, made reference to directly or indirectly in this blog will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from Halpern Financial, Inc.
To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. Halpern Financial, Inc. is neither a law firm nor a certified public accounting firm and no portion of the blog content should be construed as legal or accounting advice. A copy of the Halpern Financial, Inc.’s current written disclosure statement discussing our advisory services and fees