Focus on Time in the Market, Not Market Timing

Key Points

• Market Timing defined
• Market Timing Has Its Risks
• The Risk of Missing Out
• Use Time to Your Advantage
• Total Annual Return of the S&P 500
• Regular Evaluations Are Necessary
• Time Is Your Ally
• Points to Remember

Sports commentators often predict the big winners at the start of a season, only to see their forecasts fade away as their chosen teams lose. Similarly, market timers often try to predict big wins in the investment markets, only to be disappointed by the reality of unexpected turns in performance. It’s true that market timing sometimes can be beneficial for seasoned investing experts (or for those with a lucky rabbit’s foot); however, for those who do not wish to subject their money to such a potentially risky strategy, time — not timing — could be the best alternative.

What Is Market Timing?

Market timing is an investing strategy where the investor tries to identify the best times to be in the market and when to get out. Relying heavily on forecasts and market analysis, market timing is often utilized by brokers, financial analysts and mutual fund portfolio managers to attempt to reap the greatest rewards for their clients.

Proponents of market timing say that successfully forecasting the ebbs and flows of the market can result in higher returns than other strategies. Their specific tactics for pursuing success can range from what some have termed "pure timers" to "dynamic asset allocators".

Market Timing Has Its Risks

Although professionals may be able to use market timing to reap rewards, one of the biggest risks of this strategy is potentially missing the market’s best-performing cycles. This means that an investor, believing the market would go down, removes his or her investment dollars and places them in more conservative holdings. While the money is not invested, the market instead enjoys its best-performing month(s). The investor has, therefore, incorrectly timed the market and missed those top months. Perhaps the best move for most individual investors — especially those striving toward long-term goals — might be to continually purchase shares and hold on to them throughout market cycles. This is commonly known as a "buy-and-hold" investment strategy and “dollar cost averaging.” By making regular purchases of shares each month you do not time the market. Some months you are buying low and some months you are buying high. But on average, making regular purchases smoothes the process.

As seen in the following table, purchasing investments and then withstanding the market’s ups and downs can work to your advantage. Though past performance cannot guarantee future results, missing the top 20 months in the 30-year period ended December 31, 2010, would have cost you $17,648 in potential earnings on a $1,000 investment in Standard & Poor’s Composite Index of 500 Stocks (S&P 500). Similarly, a $1,000 investment made at the beginning of 1991 and left untouched through 2010 would have grown to $5,753; missing only the top 20 months in that span would have cut your accumulated wealth to $1,150

Though many debate the success of market timing vs. a buy-and-hold strategy, forecasting the market undoubtedly requires the kind of expertise that portfolio managers use on a daily basis. Individual investors might best leave market timing to the experts and focus instead on their personal financial goals.

Source: Standard & Poor’s. Stocks are represented by Standard & Poor’s Composite Index of 500 Stocks, an unmanaged index generally considered representative of the U.S. stock market. Individuals cannot invest in indexes. Past performance is no guarantee of future results.

Perhaps the most significant risk of market timing is missing out on the market’s best-performing cycles. Columns A, B, and C represent the growth of a $1,000 investment beginning in 1981, 1991, and 2001, and ending December 31, 2010.

Row 1 shows the investment if left untouched for the entire period shown above; Row 2 shows the investment if it was pulled out during the 10 top-performing months; and Row 3 shows the investment if it was pulled out during the 20 top-performing months.

Use Time to Your Advantage

If you’re not a professional money manager, your best bet is probably to buy and hold. Through a buy-and-hold strategy, you take advantage of the power of compounding or the ability of your invested money to make money. Compounding can also help lower risk over time: as your investment grows, the chance of losing the original principal declines.

Source: Standard & Poor’s. Stocks are represented by Standard & Poor’s Composite Index of 500 Stocks, an unmanaged index generally considered representative of the U.S. stock market. Individuals cannot invest in indexes. Past performance is no guarantee of future results.

Regular Evaluations Are Necessary

Buy and hold, however, doesn’t mean ignoring your investments. Remember to give your portfolio regular checkups, as your investment needs will change over time. Most experts say annual reviews are enough to ensure that the investments you select will keep you on track to meeting your goals.

Time Is Your Ally

Time can be a better ally than timing. Above all, remember that both your long and short-term investment decisions should be based on your financial needs and your ability to accept the risks that go along with each investment.

Points to Remember

1. Historically, a buy-and-hold strategy has resulted in significantly higher gains over the long run, although past performance is not indicative of future results.
2. A big risk of market timing is missing out on the best-performing market cycles.
3. Missing even a few months can substantially affect portfolio earnings.
4. Market timing strategies — which range from putting 100% of your assets in or out of one asset class to allocation among a variety of assets — are based on market performance expectations.
5. Market timing is best left to professional money managers.
6. Though buy-and-hold is a smart strategy, regular portfolio checkups are necessary.
7. Time horizon is particularly important when determining asset choices.
8. Riskier investments are more appropriate for longer-term goals and as goals get closer, portfolios should be rebalanced.
9. Even in retirement, portfolios should contain investments for earnings to keep pace with inflation.

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