Believe it or not, there are actually some people unhappy that the markets have risen so much this year. These curmudgeons are skeptical and worried about a market decline. Somehow they manage to be afraid both when markets are up or down. They strive to estimate when to get in or get out, a tactic called market timing.
The lure of market timing may be tempting, but outguessing markets is not as straightforward as it sounds. One primary reason is that so many investors would do so if they could. Any attempt you may make for a timing decision is really in competition with all the other investors in the world. No small task!
Attempting to buy and sell or make short term changes at exactly the “right” time involves substantial challenges. First and foremost, markets are fiercely competitive and adept at processing information. During 2018, world-wide equity trading on a daily basis averaged $462.8 billion.
The combined effect of all this buying and selling is that available information, from economic data to investor preferences and so on, is quickly incorporated into market prices. Trying to time the market based on an article from this morning’s newspaper or a segment from financial television? It’s likely that information is already reflected in prices by the time an investor can react to it.
Recent studies about the performance of actively managed mutual funds found that even professional investors have difficulty beating the market: over the last 20 years, 77% of equity funds and 92% of fixed income funds failed to survive and outperform their benchmarks after costs.
Further complicating matters, for investors to have a shot at successfully timing the market, they must make the call to buy or sell stocks correctly not just once, but twice. Professor Robert Merton, a Nobel laureate, has said it well, “Timing markets is the dream of everybody. Suppose I could verify that I’m a .700 hitter in calling market turns. That’s pretty good; you’d hire me right away. But to be a good market timer, you’ve got to do it twice. What if the chances of me getting it right were independent each time? They’re not. But if they were, that’s 0.7 times 0.7. That is .49, less than 50-50. So, market timing is horribly difficult to do.”
The US market, for example the S&P 500 Index, has logged an incredible decade. Should this result influence investors’ decision to hold equities? The often stated fear of a new market high actually has no basis. Market history from 1926 to present suggests that new market highs have not been a harbinger of negative returns to come. The S&P 500 actually went on to provide positive average annualized returns over one, three, and five years following new market highs.
Capital markets are suitable for long-term investing. Outguessing markets is more difficult than many investors might think. While favorable timing is theoretically possible, there isn’t much evidence that it can be done reliably, even by professional investors. The positive news is that investors don’t need to be able to time markets to have a good investment experience. Over time, capital markets have rewarded investors who have taken a long-term perspective and remained disciplined in the face of short-term noise. By focusing on the things they can control (like having an appropriate asset allocation, diversification, and managing expenses, turnover, and taxes) investors can better position themselves to make the most of what capital markets have to offer.