What is market timing, and does it really work?

How do you know when it’s the best time to buy or sell? And what effect does this have when the market is performing poorly? It all comes does to market timing as we explore in this article.

What is market timing?

Market timing is an investment strategy focused on picking market lows and highs, with the intention of buying securities (often shares) when they are low and selling them when they are high, and a willingness to take investment decisions based on relatively short-term market movements. Market timing contrasts with a long-term buy and hold approach, where an investor may not be so fixated on price when first investing, and typically buys with the intention of holding for a period of years.

Whilst simple in concept, in practice market timing is not so easy. The problem with market timing is that, as an old saying goes, no-one rings a bell at the top and the bottom. 

Does timing really matter?

There are many studies, conducted over a range of timeframes and in share markets around the world, showing the impact on investment returns of missing out on the best few days for the market in a given period. These studies consistently show that not being invested on just a few of the big ‘up’ days for the market will have a dramatic impact on your portfolio.

One study looked at the U.S. sharemarket over a period of nearly 40 years, and calculated the impact of missing the best 5, 10, 30 and 50 days in that period.

An investor who hypothetically invested $10,000 into the S&P 500 Index on 1 January 1980 and remained fully invested would have seen their money grow to almost $660,000 by 31 December 2018.

Missing out on just the five best days during that period would have reduced their returns by 35%, while missing out on the 10 best days would have cut returns by more than half.

Chart from Fidelity.com that shows investment growth
Source: www.fidelity.com

Turning our attention to the Australian sharemarket, a hypothetical $10,000 invested into the S&P/ASX 200 Accumulation Index on 30 October 2003 would have turned into $37,855 by 6 July 2020.

Missing the best 10 days during this period would have reduced returns by $15,424, while missing the best 20 days would have reduced returns by $23,003.

These studies illustrate the risk an investor takes if they try to ‘time the market’. Who knows when those good days, that make a disproportionate contribution to long-term returns, will take place?

Actually, there is a partial answer to this exact question that reinforces the problems with attempting to time the market: many of the best days in the market come right after the worst days.

J.P. Morgan found that over a 20-year period from 1 January 1999 to 31 December 2018, six of the 10 best days on the U.S. sharemarket occurred within two weeks of the 10 worst days.

We saw examples of this on the ASX earlier this year when the market was at its most volatile:

  • a fall of 9.7% on 16 March was followed by a rise of 5.8% on 17 March
  • after the market fell by 5.6% on 23 March to hit its 2020 low, on the following three days it rose by 4.2%, 5.5% and 2.3%
  • a fall of 5.3% on 27 March was followed by a rise of 7.0% the next trading day.

These figures tell us that it is during the very times that markets are at their most stomach-churning, and investors are most likely to be panicked into cashing out of their investments, that the most important up days are likely to occur. These are the days that make outsized contributions to your long-term returns.

Of course, remaining invested means you also remain exposed to the market’s bad times. 

What is the lesson?

The key lesson is that it is almost impossible to consistently time the market over the long term.

As the well-worn saying goes, it is time in the market, not ‘timing’ the market, that is important.

While everyone’s circumstances and goals are different, conventional wisdom is that most investors are best-advised to play a long game, get their asset allocation right, and ensure they are well-diversified.

ETFs are well-suited to this investment approach. They provide a convenient, cost-effective way to get exposure to all the major asset classes, including Australian and global equities, fixed income, cash and commodities.

You can use ASX-traded ETFs to build the core components of your portfolio. For example, the BetaShares Australia 200 ETF (ASX: A200) provides exposure to the largest 200 companies on the ASX at an annual management cost of just 0.07%.

So should I ever attempt to time the market?

By now it should be clear how difficult it is to time the market – and the risks you run if you get it wrong.

However, that’s not to say that you should pay no regard to market valuations, and adopt a ‘100% invested, 100% of the time’ approach.

Just as some fund managers take an ‘overweight’ or ‘underweight’ approach according to their market view, you can also adjust your exposure. Rather than selling everything when you think the market is getting toppy, you can look to bank some profits by selling a portion of an investment. Similarly, when the market has suffered a significant correction like we saw earlier this year, if you think that a recovery is likely, you can top up holdings, or take the opportunity to add a new investment to your portfolio.

This is very different from an ‘all in or all out’ approach. If you get the timing right, you can enjoy a boost to your portfolio returns – and if you don’t, at least taking an incremental approach means there won’t be a catastrophic impact on your portfolio.

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About Richard Montgomery 

Richard Montgomery Richard Montgomery is responsible for BetaShares communications strategy and implementing strategic marketing communications for adviser and investor audiences. Previously, Richard worked as a communications consultant to, among others, the Australian Securities Exchange, the Stockbrokers and Financial Advisers Association, and Kaplan Professional. Richard holds a Bachelor of Arts with Honours in Psychology from Melbourne University, and a Graduate Diploma in Applied Finance and Investment from the Securities Institute of Australia.

Note:

The Bear funds’ strategy of seeking returns that are negatively correlated to market returns is the opposite of most managed funds. Also, gearing magnifies gains and losses and may not be a suitable strategy for all investors. Investors in geared strategies should be willing to accept higher levels of investment volatility and potentially large moves (both up and down) in the value of their investment. Investors should seek professional financial advice before investing, and monitor their investment actively. An investment in any of the Bear funds should only be considered as a component of an investor’s overall portfolio.

BetaShares Capital Limited (ABN 78 139 566 868 AFSL 341181) (BetaShares) is the issuer of the BetaShares Bear funds. 

 

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