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Market Timing; How Do You Do That?

I have decided to return to an investment topic with these musings.  The market volatility of the past year has  doubtless driven some investors into cash and other "safer" investments.  That may well be the right move for some, but lest anyone think that they can successfully "time" the market, I offer these thoughts on the topic.

The Dow Jones average closed up over 300 points today.  That is good news for all of us near retirees who have some of our retirement savings in equites.  Of course, it closed down over 200 points yesterday, and that is not such good news.  That is pretty much the way the market has behaved for most of this year; two steps forward, three steps back.  That is the definition of volatility, and it can drive a sane person crazy if they get too caught up in the day-to-day machinations of the market. I know because I have looked into the abyss of craziness myself lately.  It is definitely unsettling to watch your meager little number shrink day by day as the market falls.  I have an idea!  Why don't we just move all of our savings into cash (money market accounts, CD's, savings accounts, etc.) until all of this craziness settles down, and the market starts to go up again, like it should?  I recently ran into an old pilot friend who told me that he had done exactly that with his  401k money.  He was going to wait this bear market out in cash and hop back into equity investments when the bear left town.  Not wanting to burst his bubble, I wished him good luck, for you see that is much easier said than done.

Market timing can be defined as "the act of attempting to predict the future direction of the market, typically through the use of technical indicators or economic data," ( and making investment decisions based on that prediction.  Mutual fund investors practicing this art switch among mutual fund asset classes in an attempt to profit from the changes they foresee coming in the market place. The idea that one can succesfully accomplish such market timing maneuvers is quite appealling, and in theory sounds like a "no-brainer."  There is only one problem.  Numerous studies have indicated that it simply does not work!  While it is very easy to look back and determine when one should have exited the market at its zenith, and also very easy to spot a market bottom after the fact, it is much more difficult to make those judgements in real time.  Additionally, a successful market timer must make two accurate calls; he must first accurately call a market top for his exit, and then he must call a market bottom for his re-entry.  That bottom call is especially difficult to make as market bottoms usually come at the point of maximum pessimism.  Market timing supposes that a practicioner can maintain a high level of discipline and ignore all of the excitement that an advancing market generates and get out, and then (even harder) ignore all the doom and gloom of the market pundits, "CNBC talking heads," and the financial press, and re-enter the market at its low point.  The discipline required for such maneuvering is beyond the grasp of most of us average investors.

Granted, there are many who proclaim that they can help you make these maneuvers successfully, and they will gladly sell you that information through a "market timing" newsletter or subscription on the web with "live, 24 hour updates."  However, none of the methods used by these "experts" have proven to return more over the long term than a buy-and-hold strategy.  Mark Hulbert, founder and editor of Hulbert Financial Digest has long tracked the returns of investment advice newsletters.  He recently cited the example of one of the most popular market timers, Douglas Fabian, the editor of a newsletter called Successful Investing.  Except for a period in the 1980s, Fabian's performance has not out performed buying and holding the Wilshire 5000 Index.  In fact, over the last 15 years it has under performed by more than 1% per year.  As bad as this performance is, it is one of the best of the market timing newsletters tracked by Mr. Hulbert.  In a widely cited study by the market academic William Sharpe, he found that to beat a buy-and-hold strategy, a market timer would have to be correct 75% of the time.  These numbers do not even consider the increased transaction costs or tax consequences.  In short, selling market timing advice is likey much more profitable that actually attempting to accomplish it.

Markets move in spurts.  Missing out on a couple of days of an upward spurt while you sit in cash can have a very negative effect on your long term results.  The table below shows just how penalizing missing just a few days of the upward movements in the market for the 10 year period from December 31, 1994 to December 31, 2004 could have been.   


Thus, most investment advisors dismiss market timing as simply wishful thinking.  John Bogle, founder of the Vanguard Group, one of the world's largest mutual fun companies and an all around smart guy, once wrote:  "After nearly fifty years in the business, I do not know of anybody who has done it successfully and consistently.  I do not even know anybody who knows anybody who has done it successfully and consistently."  Scott Burns, one of my favorite financial writers and a huge proponent of index funds, says "When it comes to market timing, more decision-makers claim success that achieve it.  Many sell far too early.  More sell far too late.  Index strategies work, not because of market timing, but because not making investment decisions works better than making investment decisions.  No one on Wall Street wants to hear this because they make their livings by making investment decisions and charging us for it." 

Someone has said that the wise man recognizes his limitations.  I realize that I do not, and cannot, know when stocks will go up or down.  Over the long term I know that they have generally risen at a nice pace.  If someone comes along who has the time and ability to successfully time the market, bravo for them.  I wish them well.  I intend to try to stick to the time-tested investment strategy of regularly adding to investments through good times and bad, and attempting to maintain an allocation balanced between stocks, bonds, and cash which allows me to ride out market downturns and sleep at night.  It seems to me that the key to building an adequate retirement fund relies more on time in the market than market timing.  I do not mean to imply that one should not arrange one's holdings in a fashion that would minimize market losses, only that many who have tried to jump in and out of the market at what they perceived to be market highs and lows have found that it worked to their detriment.  Many wise market participants have found that holding a variety of asset classes in a ratio that they found comfortable has allowed them to ride out the market fluctuations with success.  Good luck with your investments with whatever method of investing you choose.

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