Does Market Timing Work, or Is It Just a Wild Goose Chase?
Investing can result in a wide range of emotions. As you watch your investments increase in value, you’ll probably be riding a high. It’s awesome to watch your net worth grow.
Unfortunately, your investments will start going down at some point. When they first start going down, you’re okay with it because you understand no investment increases in value like a straight line.
However, if the decrease in price starts to become more pronounced, you probably start worrying. What happens if my investments keep going down? Should I sell to prevent losing all of my money? These are all common thoughts, but they don’t need to be.
How the Stock Market Works Over Long Periods of Time
The stock market as a whole has a very solid history of increasing over time. The road can get bumpy over certain historical periods, but when you stretch out your investment time horizon long enough, the stock market as a whole continues going up. This is boring. It doesn’t create headlines.
Here are three prime examples of how stock markets increase over long periods of time. Note that the Y axes on the following charts show the value of a market.
How the Financial Media Uses Market Timing to Keep You Watching and Reading
Take a quick look at the charts above. You can see plenty of time periods where the markets went up or down a large amount in a short period of time. These shorter time periods look a lot more interesting than the longer-term, slow upward trend.
If it was your job to keep eyes on your financial news TV channel or website, would you create content about the long upward trend that has continued for decades? No. It’s boring. Instead, you’d be talking about every single reason you could think about of why the stock market had gone up or down over these shorter time periods, even if it doesn’t really matter over the long term. You’d also try to predict what would happen next.
If you watch any TV about investing, you’ll see experts debate whether it’s time to buy or sell a particular stock. These people are trying to time the market. They want to buy stocks at the bottom and sell stocks at the top to earn as much money as possible.
In retrospect, it can be easy to see why some of these big market changes happened. It’s even easier to see exactly when individual stocks reach their low prices and high prices. What you have to remember is it wasn’t so easy to see why they happened at the time they were happening. The same thing goes for a particular stock’s high points and low points.
It wasn’t as simple as selling right before markets went down and buying right before they go up. No one had a crystal ball to see the future, and no one has a crystal ball today, either.
Stock market analysts gave their opinions as these events happened in the past and will continue to give their opinions into the future. Some were right in the past, but many were wrong, too. If you’re wrong more than you’re right, you could easily lose money investing.
The Negative Effect of Trying to Time the Market
Stock market timing sounds like a very enticing way to earn the most money possible with your investments. Unfortunately, trying to time the market can have major negative consequences.
“Timing the market isn’t likely to work out in the average investor’s favor. Further, to say it is difficult to accurately time the market is potentially misleading. This could imply that working harder or doing more research will improve your results. The reality is there is a degree of randomness that can’t be eliminated,” says Brandon Renfro, assistant professor at East Texas Baptist University and founder of a retirement planning and wealth management practice.
You may correctly time the market once by chance. Maybe you get out at the top of the market right before it crashes or you end up buying into the market right as it hits the bottom.
Every time you decide to try to time the market, you need to be able to do it twice to be successful over the long term. The problem is it’s rare to time the market right twice.
You need to time the market right to sell at a peak and time it right again to buy at the bottom to earn the maximum return possible. If you miss either of these events, your returns will be greatly diminished.
For example, if you were going by the S&P 500 and missed the 10 best days of the market over the 1998–2017 time period, your annual returns would be reduced from an annual return of 7.2 percent to 3.53 percent. That’s a 3.67 percent difference. If you miss the best 30 days, you’ll actually have a negative return over the 20-year period.
Of course, market timing would result in missing some bad days to offset some of those good days you missed. However, the worst days and the best days can sometimes end up close together. If you miss some of the worst days, chances are you could miss some of the best days, too.
For instance, the sixth-largest percentage drop of the S&P 500 was 9.04 percent on Oct. 15, 2008, according to CNBC. It was surrounded by some of the largest percentage gains by the S&P 500, as well. On Oct. 13, 2008, the S&P 500 increased 11.58 percent for the fifth-largest gain, and on Oct. 28, 2008, it increased 10.79 percent for the sixth-largest gain.
Stock Market Experts May Have Different Results
Some people do successfully time the market and beat the stock market returns, but it’s rare. It’s even rarer that one particular person successfully times the market many times over their lifetime.
However, some true stock market experts who have spent huge amounts of time following the market and particular companies very closely make it happen. They don’t beat the market every year. In fact, they sometimes have huge losses.
Honestly, some of the experts’ success comes from luck, too. That said, they can sometimes time deals perfectly and make huge sums of money.
You don’t have to have a formal education to do this. You can teach yourself if you’re willing to put in the time and have the money to learn from your mistakes.
Unfortunately, most people will never achieve this level of stock market knowledge because they don’t have the time and resources to make it happen. Even with the proper knowledge, timing the market isn’t just learning how to do it. You have to get a bit lucky, as well.
Watching CNBC daily and reading a few books will give you some knowledge of the markets and stocks, but it doesn’t give you the detailed information you’ll need to make smart investing decisions. In fact, much of what is shown on TV is just what sells advertising spots and gets ratings rather than teaching the fundamental information you need to learn to become a great investor.
It’s Up to You How to Invest and Whether to Try Market Timing
Ultimately, it’s up to you how you want to invest in the stock market. You can be an active investor who picks individual stocks and tries to time the market, or you could be a passive investor who uses index funds to invest for the long-term.
You can also do a mix of the two. For example, you can passively invest 95 percent of your investments. Then you can use the other five percent for crazy bets that could make you rich or end up losing everything. Just make sure that the five percent you’re making crazy bets with isn’t needed to reach your long-term goals.
Regardless of how you choose to invest, make sure to educate yourself about all of the risks involved. If this all sounds way too complicated for you, it can also be helpful to meet with a financial adviser or sign up for investment services offered by providers like Betterment to come up with an investment plan that works best for you.