Wouldn’t it be great if we knew when the market was about to go up or down? It would
sure make investing easier to do! Many investors have all sorts of strategies for
identifying the peaks and valleys of the stock market. Very few investors, however, can
do so consistently.
Our advice to our clients regarding market timing (i.e., trying to buy at market lows and
sell at market highs) is simple: Don’t try! In the book Asset Allocation, by Roger Gibson,
Gibson makes a strong case about the futility of trying to time the market. He quotes
Charles D. Ellis in his 1985 publication titled Investment Policy: “The evidence on
investment managers’ success with market timing is impressive---and overwhelmingly
negative.”
Gibson points out that to successfully time the market, you have to be right twice. You
have to identify the right moment to buy into the market and the right moment to get
out. Doing one correctly is tough to do. Doing both correctly is very difficult to do. And
repeatedly doing both is almost impossible.
Some further insight as to why market timing does not work comes from another quote in
Gibson’s book. According to a research study by William F. Sharpe, a noted investment
scholar,
…. “A manager who attempts to time the market must be right roughly three times out of
four, merely to match the overall performance of those competitors who don’t. If he is
right less often, his relative performance will be inferior. There are two reasons for this.
First, such a manager will often have his funds in cash equivalents in good market
years, sacrificing the higher returns stocks provide in such years. Second, he will incur
transaction costs in making switches, many of which will prove to be unprofitable.”
In a Washington Post article by James K. Glassman, reprinted in the Sarasota Herald
Tribune, December 16, 1996, Glassman provided additional insight on market timing:
“One investor has brilliant timing. She can sense perfectly when the market will hit its
low. So every year for twenty years she puts $ 1,000 into the Investment Company of
America, a huge mutual fund, on the day the market hits its low. A second investor has
terrible timing. He puts a $ 1,000 into the same fund each year on the day the market
hits it’s high. Of course the investor with brilliant timing does better. What’s surprising is
that her edge isn’t significant. According to Capital Research and Management, which
runs Investment Company of America, the “best day” investor achieves an average
return of 14.9%, while the ”worst day” investor’s return is 13.3%.
The important factor that led both of the above investors to do well was that they were at
all times invested in the market. Had they been getting in and out of the market with
their entire portfolio, I’m sure their returns would have been much worse.”
One study of investment returns from 1926 through 1988 showed that a buy-and-hold
investor would have grown one dollar invested in 1926 into $638.30 in 1988. Almost all
of that gain, however, 99% of it, however, occurred in just a few months during that
time. If he had missed the single best month his investment would have yielded 28%
less than the buy-and-hold strategy. Being in the market at all times, therefore, is
essential.
But what about following professional market timers’ advice? In an article by Mark
Hulbert, published in the Wall Street Journal in July 2006, Mr. Hulbert pointed out that a
market timing newsletter published by Douglas Fabian called Successful Investing had
been one of the most successful such newsletters, yet had a very mediocre record over
the previous 15 years. (Note: The Hulbert Financial Digest has tracked the performance
of market timing newsletters since 1980.)
Mr. Hulbert explained that many of the successful market timing approaches are the
outgrowth of what statisticians call data mining. Data mining involves studying historical
data to discover what seem to be patterns in the data. Mr. Hulbert stated that following
the patterns may work for a while, but they inevitably stop working once investors try to
follow them in real time.
The bottom line is that you need to be broadly diversified and be in the market at all
times. While some experts may be able to time the market in the short run, over the
long haul, it’s very tough to do!
David C. Patterson, CFP® and Erin Patterson, CFP® are the owners of Patterson Advisors, LLC, a fee-
for-service-only financial advisory firm. Patterson Advisors, LLC is a Registered Investment Advisor,
registered with the State of Michigan, helping clients in Waterford, Clarkston and Royal Oak, Michigan
as well as other Oakland County, Michigan communities . Visit www.pattersonadvisorsllc.com for more
information or call 248-674-2108.
Published in the Oakland Insider, August 2007
Market Timing is Tough to Do
By David and Erin Patterson