With the recent volatility in the stock market, including a pronounced decline over a short time frame, investors might be tempted to time the market. Some may view the dip as a good time to be buying certain stocks or exchange-traded-funds (ETFs). Others may be regretting not selling off some of their stock holdings prior to the dip. While there are certainly some professional traders who can profit from timing the market and rapid trading, for most investors this is an unprofitable exercise.
Case in point, many investors sold out of equities in late 2008 and early 2009 at the depths of the market during the financial crisis. As the major market averages had surged upward and the Dow regained the 10,000 mark, barely more than a quarter of the money that had been withdrawn from equity mutual funds by individuals had been reinvested. (For more, see: What Shook the U.S. Stock Market?)
Market Drops Differ
During the market decline of 2000-2002 that was fueled by both the Dotcom bust and then the September 11th tragedy while many major market benchmarks dropped, there were pockets where gains were actually made. In contrast the financial crisis and the ensuing market drop of 2008-2009 saw virtually no safe havens from the market carnage. Strategies that worked in 2000-2002 failed investors miserably just a few years later. Following the same course likely resulted in significant losses.
The news media has been full of stories of many investors who sold most or all of their equity holdings during the depths of the financial crisis and then have sat on the sidelines during much of the ensuing market rally that has lasted since March of 2009. Maybe they thought they could time the markets and get in and out at the right time. Maybe they were just driven by fear. Whatever their reasons they likely booked hefty losses and were then out of the market and unable to recover to a significant extent. For those who were nearing retirement the impact on their plans was devastating in many cases. (For more, see: Your 401(k): How to Handle Market Volatility.)
Buy and Hold Not a Passive Strategy
Buy and hold does not mean buy, hold and ignore. Many years ago a financial advisor who is a former stockbroker told me that buy and hold is not a passive investment strategy. He said this in part in reaction to the complaints of his clients during his brokerage days who would mistake a lack of trading activity in their accounts for indifference on his part.
This advisor was totally correct in that if executed properly buy and hold is an active strategy. The acts of establishing an asset allocation for a client, selecting the proper investments to use in implementing their investment strategy and monitoring both their allocation and their individual holdings are worthwhile activities. (For more, see: Achieving Optimal Asset Allocation.)
Models and Real Market Conditions
With the advent of enhanced computer modeling capabilities arising from better technology, it seems the number of newsletters and investment advisors claiming they can time the market has increased markedly in recent years. A good many of these models and services have come into place since the lows of the financial crisis and have never actually been put to the test in real bear market conditions. Will their buy/sell signals really work in a rapidly dropping market? Will the actual results realized by investors resemble those obtained via back-testing?
You Need to Be Right Twice
Successful market timing means an investor needs to be right twice. They need to buy the security at reasonable price. More important, they need to sell before the security heads down too far in price. Many investors can spot a bargain on the buy side. Knowing when to sell is often far more difficult. Being wrong too often on the sell side can lead to sizable investment losses. Besides logic, investors often let their egos get in the way of a rational sell decision. (For more, see: 4 Reasons Why Financial Plans Go Wrong.)
Beyond Investment Results
Trying to time the market can involve trading costs and other expenses. Buying and selling stocks, ETFs, closed-end funds and any other exchange-traded vehicles usually involves a trading commission. Even with the advent of low cost brokers these costs can add up with a number of buys and sells, especially if this is done frequently throughout the year. Depending upon the mutual fund and which custodian is used, there may be costs to buy and sell funds as well.
Financial advisors can help point out the benefits of a long-term investment strategy to their clients as a part of a comprehensive financial plan. For those clients who need the thrill of timing the market they might help them establish a trading account with a small portion of their overall portfolio. (For more, see: How Advisors Can Help Clients Stomach Volatility.)
The Bottom Line
Certainly there are those who do well timing the stock market but this is not most investors. Unsuccessful market timing can erode your portfolio and leave you short of financial goals such as retirement and funding college for your kids. (For more, see: Stock Market Risk: Wagging the Tails.)