Why You Shouldn’t Try To Time the Market
Buy low, sell high!
It’s the mantra of finance. It’s what the “professional” traders TRY to do.
The idea is great. If we always timed our investing right, we could make a killing. We’d buy when prices are cheap, sell when they’re high, and pocket the difference. Here’s the sad truth: Most of us don’t do so hot at timing the market.
Don’t feel bad. Neither do the “pros.”
96% of the professional money managers fail to beat the market over 10 years.
Here’s why you shouldn’t try to time the market.
Trying to Time the Market Destroys Your Returns
Timing the market is hard. No one really knows if the market is going to go up or down. We can make educated guesses, but they’re guesses nonetheless.
For about three years now, many analysts have been predicting that the market is going to tank. They’ll be right … eventually.
But in the meantime, I’ll keep buying low-cost index funds. For the last three years, while the market timers have been shouting “SELL” or “DON’T INVEST” I’ve generated close to 35% on my portfolio. Good thing I didn’t listen to them.
Even The Oracle of Omaha, Warren Buffett, says trying to time the market is a bad idea. In 2008 he made a million-dollar bet with the money management firm Protégé Partners. Buffet bet on a S&P 500 index fund. Protégé bet on funds that try to time and beat the market.
As of February 2017, Buffett and his S&P 500 index fund generated cumulative returns of 85%. Protégé’s cumulative returns were 22%. In other words, a simple index fund has done 4 times better than the hedge fund professionals.
It’s important to note that Buffett is using a simple S&P 500 index fund—a low cost fund built to mimic the performance of the market. It’s something we can all use. It’s not some special trick, it’s not a special skill of his, it’s not some special fund only the elite have access to. We can all do the exact same thing.
Buffett is simply matching the returns of the market while Protégé is getting killed by them.
The Oracle of Omaha bet that the pros, those who try to time and beat the market, would fail. And so far it’s looking like he’s right.
For more information on how to invest using index funds see The Best Way To Invest In The Market.
Why Is Timing the Market Is So Hard
It’s crazy to think that the pros of Wall Street, those who make millions and are neck deep in the market every hour, every day, can’t even get market timing right.
Well, in their defence, it’s hard. Really hard. Here’s part of the reason why:
- For the last 20 years, if you would have been fully invested, you’d have an annualized return of close to 10%
- If during the same time period, you would have tried to time the market and missed the 10 best days, your annualized returns would be closer to 6% (that’s just missing 10 days)
- If you tried to time the market and missed the 20 best days, your annualized returns would have dropped to about 3.5%
- If you tried to time the market and missed the 40 best days, you would have lost money over the 20 year period
- 6 of the 10 best days occurred within 2 weeks of the 10 worst days
Okay, let’s break this down and see what it means. Here’s what the market timers are up against.
- Over the last 20 years, they’ve needed to generate more than 10% annualized returns just to justify their effort.
- They need to ensure they’re fully invested on the best days. If not, their returns are cut substantially.
- About 60% of the best days are within 2 weeks of the worst days. Trying to stomach the thought of buying just after the market drops significantly is no easy feat.
- If you get the timing wrong, you could be buying high and selling low—exactly opposite of the intended goal, but that’s what many of them end up doing.
If you’re going to try and time the market, you better have a crystal ball too. Without one, you’re setting yourself up for failure.
It’s no wonder why Warren Buffett, Jack Bogle, and other investing legends warn against making such attempts.
Trying to Time the Market Increases Your Investing Costs Significantly
Timing the market is nearly impossible and it’s also expensive. Market timing strategies come at a high cost from both an opportunity and actual cost perspective.
The Opportunity Costs Of Timing the Market
As I discussed above, for the last three years I’ve been tempted to listen to many of the analysts and not actively invest—I’ve been tempted to try and time the market.
I’m glad I didn’t though. If I would have sat on the sideline I would have missed a 35% gain on my portfolio. In other words, waiting to invest would have cost me a 35% increase. Ouch!
The missed opportunities of trying to time the market generally comes at a heavy cost—one that will prolong your inability to achieve financial freedom.
The Actual Costs Of Timing the Market
Every time you buy and sell investments there’s a costs—some seen but most not.
Most investors only look at what is advertised—the per trade fee. For example, Scottrade and TD Ameritrade charge around $7 every time you buy or sell. That’s the only fee most folks focus on, but the majority of the costs are unseen and unknown.
Every time you buy or sell investments you get hit with a plethora of transaction fees, including brokerage commissions, market impact costs, spread costs, tax costs, redemption fees, exchange fees, and purchase fees.
Every one of these fees eat into your money and make market timing all the more unattractive.
Here’s How To Beat the Mistakes Of Market Timing
Alright, so trying to time and beat the market is nearly impossible, it kills our returns, and it’s extremely expensive. So then, how do we beat the mistakes of market timing?
Here’s the trick. You actively invest your money, but you take a passive investing approach. Here’s how you do it.
Every month, automatically allocate money into passive market investments, such as index funds. An index fund is a diversified portfolio built to mimic the performance of a specific market index, such as the S&P 500. Remember, this is the same type of fund Warren Buffett used to whip the returns of Protégé Partners.
Yes, investing money every month means that you will sometimes buy high, but it also ensures you’ll buy low. On average, the returns of those who have invested each month crush those who try and time the market.
The “pros” that try and time the market can’t. The investing legends don’t even try and neither should you.
So here’s the key take away—don’t attempt to time the market. Rather, beat it by investing consistently month by month. Using this strategy will save you thousands in the long run.
Set up automatic monthly deposits into your brokerage account where the money will be invested in low-cost index funds.
See The Best Way To Invest In the Market for more details regarding index funds.
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