Market Timing: What It Is and How It Can Backfire

What Is Market Timing?

Market timing is the act of moving investment money in or out of a financial market—or switching funds between asset classes—based on predictive methods. If investors can predict when the market will go up and down, they can make trades to turn that market move into a profit.

Timing the market is often a key component of actively managed investment strategies, and it is almost always a basic strategy for traders. Predictive methods for guiding market timing decisions may include fundamental, technical, quantitative, or economic data.

Many investors, academics, and financial professionals believe it is impossible to time the market. Other investors—in particular, active traders—believe strongly in market timing. Whether successful market timing is possible is a matter for debate, though nearly all market professionals agree that doing so for any substantial length of time is a difficult task.

Key Takeaways

  • Market timing is the act of moving investment money in or out of a financial market—or switching funds between asset classes—based on predictive methods.
  • If investors can predict when the market will go up and down, they can make trades to turn that market move into a profit.
  • Market timing is the opposite of a buy-and-hold strategy, where investors buy securities and hold them for a long period, regardless of market volatility.
  • While feasible for traders, portfolio managers, and other financial professionals, market timing can be difficult for the average individual investor.
  • For the average investor who does not have the time or desire to watch the market daily—or in some cases hourly—there are good reasons to avoid market timing and focus on investing for the long run.


Understanding Market Timing

Market timing is not impossible to do. Short-term trading strategies have been successful for professional day traders, portfolio managers, and full-time investors who use chart analysis, economic forecasts, and even gut feelings to decide the optimal times to buy and sell securities. However, few investors have been able to predict market shifts with such consistency that they gain any significant advantage over the buy-and-hold investor.

Market timing is sometimes considered to be the opposite of a long-term buy-and-hold investment strategy. However, even a buy-and-hold approach is subject to some degree of market timing as a result of investors shifting needs or attitudes. The key difference is whether or not the investor expects market timing to be a pre-defined part of their strategy.

Advantages and Disadvantages of Market Timing

For the average investor who does not have the time or desire to watch the market daily—or in some cases hourly—there are good reasons to avoid market timing and focus on investing for the long run. Active investors would argue that long-term investors miss out on gains by riding out volatility rather than locking in returns via market-timed exits. However, because it is extremely difficult to gauge the future direction of the stock market, investors who try to time entrances and exits often tend to underperform investors who remain invested.

Proponents of the strategy say the method allows them to realize larger profits and minimize losses by moving out of sectors before a downturn. By always seeking calmer investing waters they avoid the volatility of market movements when they are holding volatile equities.

For the average individual investor, market timing is likely to be less effective and produce smaller returns than buy-and-hold or other passive strategies.

However, for many investors, the real costs are almost always greater than the potential benefit of shifting in and out of the market.

"Quantitative Analysis of Investor Behavior," a report available for purchase from Boston research firm Dalbar, shows that an investor who remained fully invested in the Standard & Poor’s (S&P) 500 Index between 1995 and 2014 would have earned a 9.85% annualized return. However, if they missed only 10 of the best days in the market, the return would have been 5.1%. Some of the biggest upswings in the market occur during a volatile period when many investors fled the market.

Mutual fund investors who move in and out of funds and fund groups trying to time the market or chase surging funds underperform the indices by as much as 3%—largely due to the transaction costs and commissions they incur, especially when investing in funds with expense ratios greater than 1%.

Buying low and selling high, if done successfully, generates tax consequences on the profits. If the investment is held less than a year, the profit is taxed at the short-term capital gains rate or the investor's ordinary income tax rate, which is higher than the long-term capital gains rate.

Advantages of Market Timing
  • Bigger profits

  • Curtailed losses

  • Avoidance of volatility

  • Suited to short-term investment horizons

Disadvantages of Market Timing
  • Daily attention to markets required

  • More frequent transaction costs, commissions

  • Tax-disadvantaged short-term capital gains

  • Difficulty in timing entrances and exits

Criticism of Market Timing

A landmark study, called "Likely Gains From Market Timing," published in the Financial Analyst Journal by Nobel Laureate William Sharpe in 1975, attempted to find how often a market timer must be accurate to perform as well as a passive index fund tracking a benchmark. Sharpe concluded that an investor employing a market timing strategy must be correct 74% of the time to beat the benchmark portfolio of similar risk annually.

And not even the professionals get it right. A 2017 study from the Center for Retirement Research at Boston College found that target-date funds that attempted market timing underperformed other funds by as much as 0.14 percentage points—a 3.8% difference over 30 years.

According to research by Morningstar, actively managed funds have generally failed to survive and beat their benchmarks, especially over longer time horizons. In fact, only 23% of all active funds surpassed the average of their passive rivals over the 10-year period ended June 2019. For foreign-stock funds and bond funds, long-term success rates were generally higher. Success rates were lowest among U.S. large-cap funds. 

Market Timing FAQs

What Is Efficient Market Hypothesis?

The efficient market hypothesis (EMH) states that asset prices reflect all available information. According to the EMH, it is impossible to "beat the market" consistently on a risk-adjusted basis since market prices should only react to new information.

What Are Some Disadvantages of Market Timing?

While market timing has many benefits, there are some drawbacks that should be kept in mind while adopting this approach. In order to be successful at market timing, it is necessary to keep a continuous check on the movement of securities, funds, and asset classes. This daily attention to the markets can be tedious, time-consuming, and draining.

Each time you enter or exit the market, there are transaction costs and commission expenses. Investors and traders who employ market timing strategies will have elevated transaction and commission costs.

Market timing can also result in a higher tax rate because when stocks are bought and sold within a year, the profit earned is taxed according to either the usual income tax rate or the short-term capital gains rate. Finally, market timing is a complex task. Determining the right entry and exit point can be challenging because the market and its trends keep changing constantly.

Who Said, "Time in the Market, Not Timing the Market?"

Keith Banks, Vice Chairman of Bank of America, said “The reality is, it’s time in the market, not timing the market" on CNBC’s “Squawk Box" in March 2020.

Is It Really Impossible to Time the Market?

Timing the market is a strategy that involves buying and selling stocks based on expected price changes. Prevailing wisdom says that timing the market doesn't work; most of the time, it is very challenging for investors to earn big profits by correctly timing buy and sell orders just before prices go up and down.

Investors often make investment decisions based on emotions. They may buy when a stock price is too high only because others are buying it. Alternatively, they may sell on one piece of bad news. For these reasons, most investors who are trying to time the market end up underperforming the broad market.

What Is the Biggest Risk of Market Timing?

The biggest risk of market timing is usually considered not being in the market at critical times. Investors who try to time the market run the risk of missing periods of exceptional returns.

It is very hard for investors to accurately pinpoint a market high or low point until after it has already occurred. For this reason, if an investor moves their money out of stocks during a market downturn, they risk not moving their money back in time to take advantage of gains from an upswing.

Article Sources
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  1. Dalbar. "Quantitative Analysis of Investor Behavior." Accessed June 30, 2021.

  2. William F. Sharpe. "Likely Gains from Market Timing." Financial Analyst Journal, Volume 31, Issue 2, 1975, Pages 60-69.

  3. Center for Retirement Research at Boston College. "TARGET DATE FUNDS: WHAT’S UNDER THE HOOD?" Accessed June 30, 2021.

  4. Morningstar. "Active Funds vs. Passive Funds: Which Fund Types Had Increased Success Rates?" Accessed June 30, 2021.

  5. CNBC. "BofA vice chair: ‘Time in the market, not timing the market’ proves most lucrative long term." Accessed June 30, 2021.

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