Market Timing
It makes no sense for individual investors to jump in and out of the market. People who trade in that way rarely die rich, whereas the patient investor often does.
Philip Carret
Market timing is difficult. More importantly, it's unnecessary and costly.
Often times people try to time the market for one of two reasons:
They are being driven by emotions (fear, greed, etc.).
They have a short-term perspective on investing.
When it comes to investing, it's best to ignore your emotions and to have a long-term perspective.
Let's first look at why market timing is unnecessary and then at how it can be very costly.
Market timing is unnecessary
One thing people fear is investing in the market at the top.
"The market's been on fire! I don't want to buy now because it's surely going down soon."
In reality, this fear is overblown. Even if you could successfully time your purchases to avoid buying at the top and only bought after severe declines, it wouldn't make much of a difference over 3 - 5 years.
In a study conducted by Dimensional Fund Advisors, they looked at returns over 1, 3, and 5 year periods during the last century. They compared the unlucky investor who always bought at the top with the savvy investor who only bought after a market drop of 10% or more. What did they find?
Over 3 - 5 year periods, the difference in returns was only 0.3 - 0.6% per year. To state that differently, even if you bought at an all-time high, you still realized a return that was 94 - 97% as much as if you'd been able to successfully time your purchases to buy the dip.
As you can see, market timing is unnecessary. The market always goes up.
Market timing is costly
Using data from JP Morgan, Visual Capitalist created a chart to show the cost of timing the market over a 20 year period. The premise is that, by trying to time the market ups and downs, the investor inadvertently missed some of the best days of market return.
If you invested $10,000 in the S&P 500 and held it for the 20 year period, your investment would be worth $64,844.
Suppose there were some market downturns during that period and you sold your investment to avoid some of the losses. Sounds smart, doesn't it? Perhaps you were fully invested for most of the 20 years, but you happened to miss the 10 best days (out of 7,300). What effect would that have on the result? You investment would be worth $29,708.
Your attempts to time the market would have cost you over 50% of your possible portfolio value!
"Now, wait a minute," you say. "What's the likelihood that I would have missed the 10 best days? I was only selling during the bear markets."
7 of the 10 best days happened when the market was in bear market territory. And many of the best days take place shortly after the worst days.
People who exit the stock market to avoid a decline are odds-on favorites to miss the next rally.
Peter Lynch
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Key Takeaways
Trying to time the market is difficult, if not impossible.
Timing the market is unnecessary.
Timing the market is costly as you're likely to miss many of the market's best days.
Time IN the market is vastly more important than timING the market!