Back in 2020 Amon and I started a video series on our stock portfolio. We invested a lump sum of $5000 into the stock market and added another $1200 to the portfolio each month. We used this to show everyday investors how we personally invest in the stock market.
During this series, we got a lot of questions about our investing strategies. And one of the most common questions was - is it a good time to invest right now?
Whether the stock market’s doing well or poorly, people always ask us this question. And our answer always comes down to market timing. So today I’m going to cover market timing, what it is, how it can damage your portfolio and some good alternatives you can use.
What is Market Timing?
Market timing happens when you invest in a stock when you think it’s at its lowest point, and hold onto the investment until you think it’s peaked at the top of the market. Then you wait until the market returns to its lowest point, and you begin investing again. In theory, you keep doing this over and over during the course of your life as an investor.
I say “in theory,” because this is virtually impossible. No one can repeat this consistently over a long period, but of course, many still try. And trust me when I say that they fail terribly.
Let me give you an example of what it looks like when someone tries to time the market. Between 1994 and 2014 the S&P returned 10% annually over that period, yet the average investor only made a 2.4% return. How did this happen? The answer is market timing.
Why Do People Try It?
The fact is that a 10% return just isn’t sexy enough for many investors. They want the fantasy story where they buy Apple stock at a low and make 1000% returns selling at a high. It’s an exciting idea, but it isn’t even close to realistic.
Amon and I both believe in practical, consistent investing where you make 10% returns annually. When you look at investors like us, who don’t time the market, stick to a simple investment plan, and make those 10% returns, we’re doing very well.
And I feel the need to emphasize this because it can be so easy to get caught up in the hype of market timing if you do it for a year and it yields fantastic results. But can you do it every year for 10, 20, 30 years?
The fact is that if you want to retire and live on your investments, you need a consistent portfolio that can sustain you for the rest of your life. To do this with market timing, you need to read the market successfully every year for the rest of your investing life.
The Merrill-Lynch Study on Market Timing
I want to look at another data source that emphasizes the consequences of market timing on investors. It is a study by Merrill-Lynch that tracked the growth of $1,000 investments in the S&P 500 index fund, started at the beginning of 1989, 1999, 2009, and ended in 2018. The study compared portfolios that engaged in market timing, and those that didn’t. But it also looked at the effects of failed market timing.
The study found that by missing out on the biggest surges in the stock market you miss out on huge returns. Basically, when an investor uses market timing and makes the decision to pull out on a supposed high, the market will often keep going higher. This is more common than not, as it’s incredibly difficult to predict a market peak. This study looks at what happens when you miss those “all-time highs” and how it affects your portfolio.
According to the study, a $1000 S&P investment in 1989 that is never touched, will be worth $17,306 in 2018. The same investment in 1999 would have $2985, and the third investment in 2009 would be worth $3530. Now let’s compare that untouched money to market-timed investments.
If someone were to invest $1000 in 1989 but tried to time the market, but missed the top ten highest-performing months during this 30 year period (which is a likely scenario), that investment would only be worth $6,950 in 2018, compared to $17,306 if the money is untouched. If that same investor misses out on the twenty top-performing months, it would only be worth $3,328!
The remaining two time periods yield very similar results, and overall this study proves an important rule about investing - it’s not about timing the market, it’s about time in the market, and how long you choose to remain invested.
Four Ways Market Timing Can Sabotage Your Portfolio
● You are missing out on income. When you sell your investment it takes you out of the market, and you aren’t collecting that dividend income or dividend payment from that investment.
● Every time you buy and sell, you’re paying fees. Over time those fees will drag on your portfolio.
● Every time you sell, you potentially incur taxes. Optimizing your portfolio to minimize taxes is important. Consistent buying and selling make this hard to do.
● It takes an emotional toll. When you use market timing as an investor, you’re in a near-constant state of anxiety all the time. You have to check the market every day and monitor its swings, which is time-consuming, but most importantly, very stressful. There’s something to be said for depositing your money and leaving it out of your mind.
What Are Some Alternatives to Market Timing?
You’ve probably guessed by now, but I’m not a proponent of the market timing strategy. But I do have some alternatives I’d like to propose.
● Have an investment plan. Before you start investing, you should have an investment plan that you’re going to stick to through the lifetime of your portfolio. It’s a good alternative because it provides consistency you don’t get with market timing. I believe you should never buy a single investment until you have a solid plan in place. Because when the market inevitably becomes volatile, that plan will keep you grounded and focused.
● Make rebalancing part of your plan. When you rebalance on a schedule, you optimize returns and minimize risk. Rebalancing on a schedule is a great way to create consistency and avoid the urge to try market timing.
● Dollar-cost averaging. This is one of my favorite stock market investing techniques, where you put your money into the market regularly at fixed intervals over a prolonged period. Sometimes you capture a low, sometimes you capture a high, but the aim is to target average returns over time.
Hopefully, this short introduction to market timing has shown you why this investing tactic is a sure-fire way to lose money. The key to smart investing is to have a secure plan and to keep your portfolio consistent. By avoiding the temptations of potentially high returns, you’re likely to make more on your investments over time. Employing our alternatives to market timing will help you achieve financial independence and early retirement more quickly in the long run