Five Reasons Not to Time the Market
Determining the right moment to scoop up shares of Goldman Sachs(GS) or the SPDR Barclays Capital High Yield Bond(JNK) during the financial meltdown would have been like trying to catch the proverbial falling knife.
Even now, as the Dow hovers back at 10,000, disparate results from companies like Morgan Stanley(MS) and Boeing(BA) prove how difficult it is to pick a “winner in any market environment.”
Trouble is, market timing is a siren’s song that inevitably leaves investors worse off than if they had remained fully invested. Consider the following reasons not to time the market:
1. Stock prices rise more than they fall. Bear markets are brutal, no question. But their losses pale in comparison next to the gains to be made (or missed) in bull markets.
Consider the 10 bull markets since 1950. They have included several massive run-ups of more than 250%, including a 302% gain from October 1990 through July 1998. And the average bull market has lasted more than four years and returned more than 130%. The moral: Historically, bull markets have greatly exceeded bear markets in terms of both duration and return.
2. You’ll be tempted to buy and sell at the worst possible times. Market timers are most likely to buy stocks after those stocks have already gained and sell them after they’ve declined. For example, investors plowed almost $190 billion into stock funds during 1999, just as stock valuations were approaching their breaking points. Three years later, investors sold more than $800 billion worth of equity fund shares as valuations were reaching their nadir during the four months ended September 2002 — just in time to miss the latest bull market’s better-than-50% gain through early May 2006.
3. A simple buy-and-hold approach works better. A study by the Boston Financial Group (now a subsidiary of the Lend Lease Corp.) found that as of 2000, investors held their mutual funds for an average of just 2.9 years. The study concluded that investors’ high turnover reflected attempts to time various market sectors, directing money from lagging sectors to hot fund categories.
The study also showed that these attempts backfired in a big way. Investors during the 1990s gained an average of just 6.68% per year according to the study. That’s a full five percentage points lower than the average investor would have earned by simply buying mutual fund shares and holding them.
4. Even the pros can’t do it. If market timing works, why don’t Warren Buffett and the rest of the world’s smartest money managers do it? Instead, Buffett and others have made it clear that they think market timing is a loser’s game.
5. There are better ways to reduce your risk. A well-diversified portfolio will allow you to avoid the full brunt of a bear market and still share in bull market gains. The financial marketplace is volatile, but the longer you sick with a diversified portfolio of investments, the greater chance you will have of reducing risk and increasing opportunities on the upside.
During market fluctuations, some types of assets have historically been less volatile than others. Fluctuations in the price of bonds, for example, have generally been less dramatic than stock prices.
So forget about timing, and focus instead on time: That is, the amount of time you have until you need to tap your savings. That factor is the key to determining the proper balance of stocks, bonds, and cash for you — one that can weather any kind of short-term market environment while providing the growth potential and income you need.
