Investors Keep Trying To Time Markets

Investors Keep Trying To Time Markets

Of all the schemes stock market investors have come up with to try to avoid losses and/or to beat the market, market timing is probably one of the least effective. Simply put, it requires the ability to identify some kind of trigger that enables you to sell your holdings before prices drop, then subsequently finding another trigger signaling when it’s time to buy again before prices recover. Not only does this investing approach require you to be able to figure out which detail out of the profusion of available data is the correct cue for a market shift, it is useful only if you are able to see it and act on it before everyone else does. And as if that weren’t enough, you have to be able to do it every time the market swings up or down. What do you think the likelihood is of getting it right even once, let alone at least half the time?

DALBAR, a financial services market research firm, has been studying investor behavior since 1994. Their annual Quantitative Analysis of Investor Behavior (QAIB) Study has consistently found that the average investor earns well below market returns, mostly due to improper market timing. During years when the U.S. stock market sets numerous of new highs while exhibiting very low volatility, market timers don’t have much to do except ride the wave.  But when things turn choppy, as they did in 2018, market timing skills are put to the test. And they usually fail. The latest QAIB study found that the average investor lost 9.4% last year despite the fact that the S&P 500 lost only 4.4%. In other words, a buy-and-hold strategy would have significantly outperformed the average market timing strategy, at least in 2018. As Cory Clark, DALBAR’s Chief Marketing Officer, explains it, “Judging by the cash flows we saw, investors sensed danger in the markets and decreased their exposure but not nearly enough to prevent serious losses. Unfortunately, the problem was compounded by being out of the market during the recovery months.”

It’s understandable that when we sense higher market risk ahead, we become more conservative with our investments. But the degree to which investors underperform the market when uncertainty grows suggests that they tend to strongly overreact. And according to DALBAR this behavior occurs with regularity. Is there a better approach to investing, particularly when saving for retirement?

Here’s one: before even considering how to react to market shifts, it’s important to have put in place a long-term investment strategy that you expect will provide the needed funding for the things you want to do during your post-retirement years. Without that you will find yourself investing without purpose and it will be all too easy to make buy and sell decisions based solely on short-term market fluctuations. Once you do have an investment strategy, market timing on a small scale might be helpful if you do not have the intestinal fortitude to be able to ignore market ups and downs. For example, if your strategy calls for your portfolio to be invested 60% in stocks, you might consider reducing that amount to 55% if you’re getting nervous. Of course, you’d still need to figure out at what future point to undo the deviation. While this is still market timing, even if you get it wrong (which you probably will), the impact on your portfolio should not be significant.

Investment decisions should be based whenever possible on rational thought rather than on emotion. But we are human beings, and the DALBAR research demonstrates that humans persistently become dysfunctional when volatility drives emotions. Market timing not only doesn’t work, it cannot work with regularity. But if doing it helps to mitigate your negative emotions, and you can do it in a restrained way that doesn’t do your portfolio any real harm, perhaps it’s OK. But please be careful.

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