When reading or hearing all the noise in the media around the levels of the stock market it can be very tempting to try and guess when is the right time to dip in or dip out.
But evidence shows that it is extremely unlikely that an investor can time markets successfully over the long term. This is even true for the “”professionals” and the 2019 SPIVA US Scorecard found that over the 15-year horizon, over 89% of active managers failed to outperform their benchmark across all domestic funds (source: SPGlobal http://bit.do/fhfKP).
Despite the evidence however, our human nature has us believe that we may be in the small minority that can actually do it.
Before you potentially make this mistake, here are 5 reasons why market timing is not a sustainable strategy.
- Market timing requires that you know exactly when to buy into and when to sell out of the market.
The probability that an average investor would have access to the information to make successful market timing decisions long term is very low. As we said even professional investment managers fail to achieve this over the long term.
- Risk of missing out on gains
By selling out of the market, you risk missing out on potential gains should the market go upwards. For example, compared to being invested over all days January 1980-January 2019, missing out on just 5 of the best days for investment return would have reduced your total return by 35% (Source: Fidelity http://bitly.ws/6Jbn).
- Loss aversion
Humans dislike losing out more than they like winning, this is known as loss aversion. In investing this can lead us to make short term panic decisions in an attempt to recover losses. These short term emotional decisions can be very costly to investing success.
- Over confidence
It is natural human bias that we believe our abilities are higher than the average person. A study by AAA found that 73% of drivers in the US believe their driving skills are better than the average
(Source: AAA http://bitly.ws/6Jbf). With investing, we may agree in principle that market timing doesn’t work but we may also think we are the exception to the rule.
- Making decisions based on past performance or cycles
The temptation to sell out of markets may be high, particularly during prolonged periods of growth, similar to years of late. There could be a drop in the market approaching or it might not come for many years and we have no way of knowing. By selling out of the market due to gut feelings that a crash is approaching, we risk missing out on further periods of growth.
Investing in markets naturally involves risk. In order to achieve the returns of the market, you must also experience the risk. By sticking to a strategy that relies on time in the market rather than timing the market, investors can benefit from both the ups and downs of market volatility without the unnecessary added risk of speculative market timing strategies.