Markets will easily rattle you. A couple hundred-point swing here. A doomsday headline there. But before you go and flee the market or try to strike it big through market timing, you have to stop and consider the consequences.
Market timing may be one of the most controversial topics around – many say it’s impossible, while the exact same number of people will claim they can do it perfectly every time.
It’s true that markets move in cycles and general predictions can be made about what to expect. But, this is exactly where investors get themselves in trouble. These facts do not mean that you can accurately and consistently get in and out of the market at the exact right moments.
Why, then, do investors continue to engage in this self-destructing behavior? Maybe it’s the same reason that we’re all pulled to the neon lights on the Las Vegas Strip – we all want to prove that we can win big and beat the game. Sometimes you do, and when you do, luck is almost a bigger factor than anything. But most of the time you don’t. When you don’t, it’s easy to keep pouring money into the machines to try and prevail. What usually happens is you fly home with your tail between your legs, in a deeper hole now than when you arrived.
4 Reasons Why Timing the Market Fails as a Money Maker
Here are four reasons why timing the market fails as a money maker:
1. It almost always hurts your performance over the long-term. A recent analysis of investor behavior from SigFig found that during the market correction in October 2014, roughly one in five investors reduced their exposure to equities, mutual funds and ETFs, with 0.6% selling 90% or more. While this may have seemed like a smart move to investors at the time, SigFig found that the more investors sold, the worse their investments performed. Investors who panicked the most had the worst 12-month trailing performance of all groups.
2. It can cost more than you will make. Market timing prompts investors to be active. While active investing isn’t necessarily a bad thing, it can be costly. And the more active you are, the more you will pay in costs. Every time you make a trade, you will incur fees associated with the cost of making that trade. Investment decisions also have tax consequences. If you try to time the market and make trades without regard for the tax impact, you can find any returns you may make quickly squashed by a tax bill.
3. You have to be right twice. Gambling is easy – you only have to be right once to make it big. Market timing is a different animal. You have to be right twice in order to win, because investing has two sides, buying and selling. To be a master at market timing, you have to be able to sell at the precise moment that the market has reached the top of its climb and can’t go any further. Then, you have to be able to buy at the precise moment the market bottoms out, before it rebounds. Do you have the guts to make that bet?
4. Your focus is on reward, not risk. Investors who time the market are in it to reap big rewards – no matter the risk. You’re chasing the high of making it big, of greed. When you don’t get that reward, you run into big problems. A focus on winning doesn’t prepare you for a loss. You have no exit strategy when things go south, and they often will. In case you’ve forgotten, higher risk doesn’t guarantee higher returns. It just means a higher chance of you losing your money. If you have a high probability of losing money, you better have something to catch you when you fall.
Why Does It Matter to You?
The truth is that investors who adhere to one extreme or the other – impossible or possible – regularly find themselves less successful than investors who try to find a happy medium.
Everyday market volatility can do enough harm to your returns, without you throwing in a little extra turbulence yourself from trying to time the market. In fact, volatility is what makes market timing difficult to do, because markets can rise and fall close together. Reaching your full financial potential depends on engaging in the right types of active investing, on a balancing act between your active and passive strategies. And this doesn’t include market timing. The only form of active investing proven to work is trend following. To take it a step further, indexing almost always outperforms active investing. This is why your main goal as an investor shouldn’t be to strike it rich from one big pop of luck. Rather, lower volatility and consistent returns – even if they’re lower returns – will increase your dollar growth, make for a smoother investment ride, and help you avoid bad investor behavior by keeping you disciplined.
Our investment strategies are built on these very principles. They move with the market, but can avoid the big declines. They limit investor exposure while still capturing upside potential. Remember, it’s not timing the market that drives your success, but time IN the market.