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Timing the market is more commonly known as the investor’s golden rule: Buy low, sell high. It is the practice of building your purchases around expected changes in the price of an asset. (For the purposes of this article we will refer to stocks and the stock market, but timing can refer to any market and asset, including bonds, currencies and commodities.) Someone attempting to time the market will buy an asset that they expect to go up in value. But rather than holding the asset through ups and downs, they will sell when they believe that it’s about to start decline.

That’s timing the market. And it doesn’t work.

Understanding Market Timing

There are many reasons why you would buy or sell a security. Common wisdom suggests that everyone should invest as market timers, buying an asset because it’s cheap or selling because it has gained value. In fact, though, this is just one way to invest, and a generally uncommon one. Other approaches include:

  • Buying or selling based on your financial plan, making changes to your portfolio around a predetermined position.
  • Moving assets based on company fundamentals. If a company’s performance or business model changes you might either buy or sell its stock based on how that changes your impression of its value.
  • Making changes in your portfolio based on long-term trends. If a stock has gained the value you wanted it to, or if it has trended weak for long enough to undermine your confidence in its long-term potential, you might make changes.

These are just a few examples. There are as many reasons to move assets as there are individual investors.

Market timing is when you buy or sell specifically because you expect a specific change in the stock’s price. If you think the stock will go up you might plan a sale. If you think the stock will go down, you might sell immediately. By contrast if you think the stock will go down you might plan a buy order, while if you expect it to go up you might buy immediately. It is a form of active management.

In all cases, market timing is based entirely on price volatility. While issues such as asset fundamentals and financial planning might play a role in your decision making, they are simply elements of a decision that revolves around anticipated changes to the price.

The goal of market timing is to turn these predictions into a profit. By timing your purchases and sales you can move before the market does and collect the profits.

Buy and Hold

The opposite of market timing is called “buy and hold.” As the name suggests, this is when you buy a given asset and hold it for a long period. Typically buy-and-hold investors own their assets for years.

Under this model, you will generally buy and sell based around a predetermined financial plan. Instead of trying to capture near-term price changes, you will decide in advance what you want your position to look like and how you want it to change over time.

Market Timing Does Not Work

Market timing is the holy grail of investment. It’s like flipping a house. All you have to do is grab the asset at the right moment, sell it at the next right moment and bag the easy riches.

Like everything else that promises easy money, this is an illusion.

Overwhelmingly investors who try to time the market lose money as compared to those who buy and hold. How badly do they do? Numerous research studies by disinterested parties demonstrate the failures of market timing. To pull just a few examples:

  • A study by Merrill Lynch found that model portfolios over a 30-year period could underperform by nearly half their value through market timing.
  • An experiment by Seeking Alpha found that market timing investors need to be literally perfect in order to outperform a long-term investment by even 2 percent.
  • Charles Schwab tells us that their “research shows that the cost of waiting for the perfect moment to invest exceeds the benefit of even perfect timing. And because timing the market perfectly is, well, about as likely as winning the lottery, the best strategy for most of us mere mortal investors is not to try to market-time at all.”
  • A survey by Putnam Investments found that market timers who miss just 10 days in the market could lose up to half the value of their portfolio. Their model found that getting it wrong by no more than a month was the difference between $6,873 in returns and $30,711.

We could go on.

Does this mean that market timing is impossible? Of course not. In 2002 no less than the Federal Reserve found that it’s theoretically possible for a timed portfolio to outperform a buy-and-hold approach. Charles Schwab’s research found that a hypothetical investor with perfect timing posted 7 percent better returns than buy-and-hold comparisons. The catch is the “perfect” part.

Why Market Timing Doesn’t Work

In a nutshell though, market timing has several fundamental flaws. They include:

  • It is an emotional approach to trading. It plays on a combination of greed and the investor’s natural urge to just do something. Buy-and-hold investing is a highly passive strategy and this makes it difficult for many investors who want to feel like they have a hands-on relationship with their money. Market timing gives that sense of action.
  • It depends on perfection. In order to successfully time the market you must get the highs and lows exactly right. If your timing is off by even a month or two, you can lose a significant amount of money. That degree of perfection is functionally impossible for most, if not all, investors to pull off.
  • It denies the market’s volatility. In the short term the stock market is highly volatile and unpredictable. No one can predict what will happen with stock prices over a period of months because those prices depend on short-term events and individual trading behavior that is fundamentally unpredictable.
  • It also denies the market’s stability. In the long term the stock market trends upward. While unpredictable events cause equally unpredictable volatility over a period of months, over a period of years investors can build their positions around known, predictable fundamentals.

The last two are essential. By trading on short-term unknowns, market timers expose themselves to volatility. By selling whenever a stock looks weak they can lose out on the long-term gains that come from the stock market’s overall stability. The market timer thinks in months, while the stock market grows over years.

Bottom Line

What makes market timing particularly dangerous is just how many companies promise to help you do it. Countless investment advisors, funds and (most often) retail products promise huge gains based on market timing. A quick Google search will net you dozens of products that offer to help you time your own portfolio based on specialized data and secret techniques. You could spend thousands of dollars on newsletters alone, each promising stock tips and strategies for moving assets at the right moment.

These are get-rich-quick scams. The only person making any money off of these products are the people who sell them. At best, they are basic data packages and industry newsletters. At worst they are con jobs. But they keep the myth alive. After all, imagine if you could sink $10,000 into that hot stock just before it exploded and sell exactly when it peaks? We’re all just one perfectly timed pair of trades away from retirement.

Tips

  • Consider talking to a financial advisor about how to decide when to buy and when to sell a security. Finding the right financial advisor who fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors in your area in 5 minutes. If you’re ready to be matched with local advisors who will help you achieve your financial goals, get started now.
  • Market timing bears some similarities to – but is not identical to – trend investing. Technical analysis figures prominently in trend investing, and can reap rewards for disciplined investors.

Photo credit: ©iStock.com/Altayb, ©iStock.com/porcorex, ©iStock.com/domoyega

Eric Reed Eric Reed is a freelance journalist who specializes in economics, policy and global issues, with substantial coverage of finance and personal finance. He has contributed to outlets including The Street, CNBC, Glassdoor and Consumer Reports. Eric’s work focuses on the human impact of abstract issues, emphasizing analytical journalism that helps readers more fully understand their world and their money. He has reported from more than a dozen countries, with datelines that include Sao Paolo, Brazil; Phnom Penh, Cambodia; and Athens, Greece. A former attorney, before becoming a journalist Eric worked in securities litigation and white collar criminal defense with a pro bono specialty in human trafficking issues. He graduated from the University of Michigan Law School and can be found any given Saturday in the fall cheering on his Wolverines.
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