Why Market Timing Doesn’t Work
We live in interesting times, and current events repeatedly get reflected in the stock market. This is to be expected, as is the resulting short-term volatility of the market.
But let’s face it: Expected or not, market volatility often results in emotional volatility. You may want to sell your losing stocks and get into cash when the market drops and your portfolio value falls too. On the flip side, when the market climbs to dizzying new records, you may feel anxious that you’re missing out and succumb to speculative trading that is all flash but no fundamentals.
This is called market timing, and in our view as fiduciary financial advisors, it is not an optimal strategy. To be successful at market timing, you need to know exactly when to sell so that you cut your losses, and you need to know exactly when to buy so that you don’t sit on the sidelines as the indexes climb again.
Jumping in and out of the market can be a recipe for fewer earnings over the long term. Consider the following chart, which shows the financial impact of trying to time the market.
Along with trying to avoid the market’s worst days in periods of volatility is the potential for missing its best days:
What Investors Can Do Instead of Market Timing
Most investors would be well-served by ignoring short-term market fluctuations and instead focusing on the long game. And what is the long game? It’s your goals, like retirement or your children’s education tuition. You want a certain amount in your portfolio to help achieve those goals, so you choose investments with the potential to help you attain the returns you need over time.
Your portfolio should be diversified so that if one area—say technology—declines, the other areas may fall less or not at all. This helps insulate your portfolio against current market gyrations and helps set you up for long-term goals achievement.
Your risk tolerance is essential as well. By investing, particularly in equities, you take on risk because no one can predict what the market or economy will do. We could have a recession, or the market could crash. And when these events happen, they scare us. We can lose the long view and focus on the current drop so much that we give in and start selling, undoing all our careful work.
Knowing your risk tolerance can help you create a portfolio with enough risk to help achieve the returns you seek but not so much that you react. It can help you sit out short-term market maneuvers and provide confidence that you’ll be OK. You can work with a financial advisor to assess your risk tolerance and create a portfolio that reflects it.
There are also online calculators to help you assess your risk tolerance, although be aware that many of them are offered in the hopes you will buy the financial product or service of the company offering the calculator.
Final Thoughts
Investing has changed in recent years. The positive is that more and more retail investors are participating, but algorithms are also driving trading, taking just nanoseconds to make decisions. You’ll need to make investing a full-time job if you want to have a hope of being a successful market timer. (Check out this Forbes article for more information on how modern investing works and market timing doesnt.)
For most people, market timing won’t work. The dynamics of the market and our own cognitive biases/emotional reactions will cause us to lose the returns we could have earned.
We suggest that a better alternative to timing the market is to put time in the market. Take a long-term view of your investments, and build a diversified portfolio that incorporates your risk tolerance. Earmark a portion of your paycheck for regular contributions.
You can also work with a financial advisor who will help select a portfolio as part of your overall financial plan and objectives. The advisor can serve as a coach during market volatility, helping you remember your end game and stay on track.
We offer a complimentary 15-minute call to discuss your financial situation and concerns and share how we may be able to help.
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