Oh boy! Nothing like a good bear market/recession quick-slider combo to stir the simmering pot in the investing world! There’s no need for a long introduction. Let’s dive into the meat: why market timing still doesn’t work.
“Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves”.
Peter Lynch
WTF is Market Timing?
Let’s back up. About a month ago, as stock prices began to slide like a 40-year old shirtless man on a Vaseline-covered playground set, I posted this: I have Cash! Is Now a Bad Time to Invest?
In the above-linked post, I discussed the difference between two common strategies employed by long-term passive investors: lump sum and dollar-cost-averaging. My implicit assumption is that most investors have been schooled in the match-don’t-beat-the-market and buy-and-hold philosophy as a winning game. Maybe not though.
Below is a brief summary of the two prominent passive investing strategies. In both cases, I’m assuming the investor is buying broad-based and low-cost index funds, and is also planning to hold those shares for the long run, likely decades. Finally, we’ll contrast these two methods to a market timing strategy.
Lump Sum Investing
Just like it sounds. I take a lump of money ($10,000 for instance), buy a bunch of shares with it, and then go take a nap. I wake up 40 years later, see lots of money, and rejoice. This is the very definition of matching the performance of the market as a whole. The simplest of the simple.
Dollar-Cost-Averaging (DCA)
This one doesn’t spell out as simply. Let’s say I take the same $10,000. Instead of buying shares with it all at once, I divide that sum into two or more allotments and invest at regularly-timed intervals. For instance, I could decide to invest $2,000 per month for five months. At the end of five months, I’ve invested the full $10,000 over different market conditions. At the end of 40 years, I’ll still see lots of money. Maybe less than had I just bought $10,000 worth of shares at once, but still plenty of money.
Most long-term investors do the bulk of their investing with a dollar-cost-average method. Unless we are the beneficiary of a lump sum of cash (stock grant, inheritance, severance package, etc.), we usually just invest what we can, when we can, in regular (and indefinite) increments.
Most folks will invest in a 401(k) each pay period. You might strongly consider contributing to a Health Savings Account (the ultimate retirement account). If there’s money left over, maxing out a Roth IRA is a good idea. Additional funds can be used to invest in a personal brokerage account. All this and more is covered in Part 2 of our investing strategy.
The market is up? Who cares? Invest.
The market is down? Who cares? Invest.
Uncle Billy says bitcoin will make you rich? Who cares? Ignore him. He’s always drunk anyway, and he smells like mothballs and motor oil.
Market Timing Investing
Market timing is an active investing strategy, the essence of “buy low, sell high.” Investments might be made using a DCA or lump sum approach when markets are in good shape. However, when dark clouds begin to form, investments are liquidated for cash at the peak of a bull run. Later, as the sun begins to shine and the market hits the bottom, the investor can buy back in at a supreme discount.
This sounds amazing! Why not just get your money out when times get bad? Wait for a better deal!
Glad you asked! I wrote an entire article about it!
Bottom Line: Long-term passive investing is based on the premise that investments are made or held continuously, with complete disregard for market conditions. The goal is to simply match broad market performance, not beat it. Active investors, on the other hand, might move money in and out of the market as price conditions change, a practice known as market timing.
Market Timing is Very Attractive
Despite everything written above, all investors feel the sexy—or more likely, comforting —allure of market timing. A commenter on a recent post exclaimed that “everyone and their dog” expected a market fall from the coronavirus global pandemic—the commenter’s justification for removing money from the market.
For the record, I felt it coming, but I think my dog missed the signals.
(Related Post: The Sky is Falling: Lessons from the Coronavirus)
So why didn’t I pull my money out of the market and save myself from literally hundreds of thousands of dollars of paper losses?! Why didn’t I just wait until the market bottoms out and then get back in?
Humans are a flawed and knotted bundle of fallible emotions and psychology. In theory, market timing could increase investment returns substantially, or at least save the investor from devastating losses, right? Theory and reality are two very different ball games.
“In the financial markets, hindsight is forever 20/20, but foresight is legally blind. And thus, for most investors, market timing is a practical and emotional impossibility.”
Benjamin Graham
Few Investors Can Effectively Time the Market
The problem is, as Paul Merriman puts it, precious few investors can execute a proper timing call. Executing a proper market call over many market cycles and decades of world events is an even more daunting task. And we’ve discussed all the reasons: even with technical indicators, it’s incredibly difficult to time the market. One must keep a very watchful eye on market data, a psychologically-draining endeavor.
Even with copious amounts of technical data, market timing attempts still usually fail. Too often, folks cash out too early, and get back in too late. Or worse yet, uncertainty and fear can result in cashing out late in a crash. The shell-shocked investor is battered by realized losses, and only gets back in the market long after prosperity has returned. All of a sudden, buy-low-sell-high turns into sell-low-buy-high.
“I don’t think more than perhaps one in 100 investors will be successful using timing.”
Paul Merriman
A Few (of Many) Market Timing Studies
Merrill Lynch shows us why missing out on time in the market ultimately costs us much more.
Despite a tried-and-true dollar-cost-averaging strategy that’s worked for years and years, we always want to be doing something. Sitting on our hands is hard; the psychological burden of losing money is far stronger than the joy of watching it grow. In this linked article, Vanguard noted (from a 1999 study cited below) a 7.1% average annual (!) portfolio return difference between the 20% least active traders and the 20% most active traders.
That’s why 95% of active investors underperform the market.
Another MarketWatch study showed how less than 3% of market timing newsletter subscription services offered stock-picking advice that beat the overall market performance.
Or how about this study? Among many findings suggesting that market timing underperforms, researchers noted that investor behavior is the number one cause of underperformance. A second leading cause for underperformance are the fees.
Bottom Line: Investors aren’t particularly good at timing the market, with or without the help of financial professionals. Indecision = degraded performance.
(Related Post: Financial Advisor: Who Needs One?)
A Hybrid Approach
We (the CC’s) take an admitted hybrid approach during times of increased volatility. We are 95% DCA investors, whereby we have a set-it-and-forget-it monthly investment (flat rate) to our brokerage account and biweekly investments to 401(k) and HSA accounts as paycheck deductions. Well, at least until I quit my job.
However, when the market takes a sharp dive, we get itchy like everyone else. Yes, we too are susceptible to wanting to do something.
We want to throw more money at it, eager to snatch up shares on discount. Others, concerningly, want to take their money out of equities, intent to cash out while the market falls and get the real discount when the market bottoms out.
At first consideration, the latter option seems the best. Sell high and buy low dude! If you want stocks on sale, no better way than to cash out at the top and buy back in at the bottom! And in hindsight, looking at bygone S&P 500 data, that seems very reasonable. But the difficulty comes in picking the high and the low. Where are we now?
“…The only value of stock forecasters is to make fortune tellers look good…[we] believe that short-term market forecasts are poison and should be kept locked up in a safe place, away from children and also from grown-ups who behave in the market like children”.
Warren Buffett
Market Timing: So, Have We Hit the Bottom?
On March 23rd, the S&P 500 closed at 2,305, down over 30% from the February high. Three weeks later, and we haven’t seen a drop below that point. The close on Thursday was 2789, now placing us about 18% below the market high.
Was March 23rd the low?
Will the market drop again?
Was the worst of the economic crisis baked in early in the market drop?
Are we already on rebound?
Seriously, how do you know? For the convinced market timing people, what are you thinking now? When will it be clear that the market is returning to the relentless rise of stock prices? If March 23rd was the low, the wait-and-see investor has already missed a 21% growth opportunity!
Or it might fall again. Deeper even. Who knows?
All this gives me a headache. It’s so exhausting to try and predict.
Bottom Line: All of this uncertainty highlights the fundamental problem with market timing: market highs and lows are nearly impossible to pick in real-time. Furthermore, market timing requires being lucky twice: getting your money out at (or very near) the market high, and buying back in at (or very near) the market low. The worse your timing, the more you suffer either money lost or depressed returns.
“The idea that a bell rings to signal when investors should get into or out of the stock market is simply not credible. After nearly fifty years in this business, I do not know of anybody who has done it successfully and consistently. I don’t even know anybody who knows anybody who has done it successfully and consistently. Yet market timing appears to be increasingly embraced…”
John C. Bogle
Passive and Market Timing Example Investor Portfolios: Paula, Juan, and Timothy
Let’s take a look at three example (fictional) portfolios from January 3, 2007- February 3, 2020. This fun little model assumes all investors purchased shares of the VTSAX index fund. Please note: models do not include dividend payouts or reinvestments. They are also not inflation-adjusted. We’re also only analyzing the equity portion of a portfolio and are assuming that bond holdings are minimal (not modeled). I’m far too lazy for all of that, but you will get the idea.
All models end on February 3, 2020, the final investment period for the three investors for the bull market run.
Dollar-Cost-Average Paula
Paula wants to do a dollar-cost-average, buy-and-hold strategy. She has $1000 free to invest each month. On or around the 3rd of each month, until February of this year, Paula has diligently invested $1000 each and every month in her favorite VTSAX index fund, never deviating from her plan.
By February of 2020, Paula invested $158,000 and her portfolio is now worth $320,728.85. Despite losing nearly half of her life savings in the Great Recession early in her investing career, Paula has more than doubled her money in the stock market over this time.
Good job, Paula.
Lump Sum Juan
Juan had a fat wad of cash lying around in 2007. Like Paula, he is going to invest $158,000, but Juan is going to invest it all at once. He either doesn’t have any more to invest, or isn’t really into it. In February of 2020, Juan logs on to Vanguard to see that his $158,000 initial investment is now worth $372,345.76.
Juan lost big time (!) in the Great Recession, but he stayed the course. Or he forgot. Doesn’t matter.
Daammmnnn Juan! Solid work.
Market-Timing Timothy
Timothy is a sharp cookie. He’s read a lot about investing and he knows a thing or two. He’s meticulously studied timing indicators and market fundamentals. Timothy, like Paula, begins with a DCA strategy in January of 2007. However, by March of 2008, he’s getting itchy. Timothy sees the writing on the wall and cashes out his investments. Not the top of the market, but close.
Timothy doesn’t get back in until August of 2009, well after the recession is called over and stocks are making a strong comeback. He wishes he would have gotten back in earlier, but this is pretty good. Plus, so many people were saying it wasn’t over! Timothy makes the following market timing calls from 2008-2019.
March 2008: Stop investing, cash out
August 2009: Start investing all previously-held proceeds
October 2011: Stop investing, cash out. Double-dip recession fears?
February 2012: No double-dip recession. Darn. Start investing all previously-held proceeds
December 2018: Stop investing, cash out. This has got to be the end of the bull market!
June 2019: Nope, it wasn’t. Start investing all previously-held proceeds
By early February 2020, Timothy now has $242,408.65, significantly underperforming both Paula and Juan. Well, hell’s bells!
Timothy worked so hard and read every article! Lazy Paula and Juan crushed it, and they did nothing! Those meddling kids!
(Related Post: Shocking Headlines of the 2008 Financial Crisis, and Why They Are So Important Now)
Market Timing and Taxes
You know what wasn’t accounted for in all of Timothy’s market timing and money shuffling? Taxes.
Each time investments are sold, a capital gains tax is imposed. Capital gains tax rates are income-based, and range from 0-23.8%. See the tax tables wonderfully summarized by Michael Kitces below for long-term (held greater than one year) capital gains and income tax rates.
Of course, I’d be remiss to mention that capital gains losses can be used to offset gains. But still, what a mess, right?
Keep in mind that if you want to get out of the market, cashing out perhaps hundreds of thousands of dollars in equities, expect a very large tax bill. If you plan to do this often, expect a major hit to your bottom line.
Depending on the broker, selling fees may also be incurred each time a fund is sold.
Market Timing is a Complicated and Often Unsuccessful Strategy
As you can see, market timing is complicated. In theory, market timing seems like the ultimate solution. Who wouldn’t want to sell at the top and buy at the bottom?!
The problem is that our emotions get in the way. It’s incredibly difficult—as we are seeing in real time—to pick market highs and lows.
Once market timing decisions are made, the investor has to be prepared to move very large sums of money in and out of the market, incurring large tax obligations. Even writing this feels exhausting.
I’m in this for the long haul. How about you? I’m a man of data, and data shows that those who do nothing are rewarded. I will be rewarded the returns of the stock market as a whole, and that’s good enough for ole’ Uncle CC. But first we shall wait.
“Patience is bitter, but its fruit is sweet.”
Aristotle
Either Way, Investing Still Matters
I know, I’m being kind of harsh to the market timers. But to be completely honest, those who invest in unoptimized ways will still probably make a return. The return is less likely to match the performance of the market as a whole, but it’s still a return.
How about those who don’t invest at all?
This well-crafted New York Times (opinion) article highlights the shocking wealth inequality in America. In it, the authors points out that most Americans own little to no stock, so they haven’t reaped the rewards of the 11-year bull market wealth-building machine.
Imagine simply saving $100 a month⏤perhaps a few less burritos or martinis⏤and investing that money in a low-cost index fund. That small change can markedly impact one’s financial future over the long-term.
For those that don’t invest, is there even a tiny bit of margin to get going? Is there any spending that can be cut to invest in yourself or your family’s future? I know it’s not an option for everyone, but honestly ask yourself if it’s an option for you.
You can start small…just start.
Just a thought from a guy with a laptop and a bandana mask. Stay safe everyone, and stay home.
-With love, Mr. CC
If you are trying to time to the market, have we already seen the bottom?
How does it feel investing or persevering through a bear market?
How are you doing during these times?
Let me know in the comments below!
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“Uncle Billy says bitcoin will make you rich? Who cares? Ignore him. He’s always drunk anyway, and he smells like mothballs and motor oil.”
But Uncle Bill always has “hot” tips and the best conspiracies!
Sorry! This landed in my spam folder for weeks. I think the use of “hot tips” gets the spam bots fired up!😂