Timing The Market Is A Loser's Game
You cannot lose, if you do not play
Let’s try something new today, I want to start this post off with a reader poll:
Here’s some recommended reading (after your done this post) based on how you answered:
If you answered a recession read this.
If you answered interest rates, read this.
If you answered a stock market crash, read this.
The reality is that if you are properly diversified—say in an low-cost index fund—You are the biggest threat to your investments.
The easiest way for index investors to lose money is to try and time the market.
What is market timing?
Market timing is an investing strategy where investors move in and out of the market in an attempt to avoid losses and buy back in at the bottom after the market crashes.
Investors who time the market believe that they know what will happen in the stock market. Anyone who thinks that is delusional because no one knows what is about to happen in the stock market.
Someone trying to time the market would sell their stocks if they believed the market was about to crash. In doing so, they would avoid the pain of the losses that come with a market crash.
When the market has hit bottom, they would reinvest all of their money and ride the market back to the top and make themselves rich. It’s the ultimate embodiment of “buy low, sell high.”
The idea of market timing is a great narrative, but when we begin to examine it closely, it becomes clear that it is nearly impossible to pull off in reality.
Market timing plays into our biases
Rational investors with a long-term investing horizon understand and accept that the stock market is incredibly volatile in the short run and very profitable in the long run.
Enduring the painful volatility in the short run is the price we must pay for the immense profits of investing in the long run.
But losing is painful, and the human brain is hardwired to avoid pain. We all suffer from “loss aversion.”
We hate losing even more than we love winning. That leads people to make irrational fear-based decisions that they believe will help them avoid pain. As Master Yoda would say, “Fear is the path to the dark side.”
It’s bad enough that the human brain is prone to loss aversion, but humans are also likely to be overconfident in our abilities. Many investors accept that market timing is generally a bad idea, but somehow they believe they are the exception to the rule. “Market timing doesn’t work for most people, but I am smarter than most people, and I have been studying the markets for a long time.”
When you combine the biological urge to avoid pain with overconfidence, you can understand why so many investors try and time the market.
If you can’t take the pain, you don’t deserve the gains
Ask yourself why someone would invest in the stock market in the first place?
The answer is obvious; investors put their money in the stock market because it offers superior expected returns compared to other investments.
The reason the stock market has such high expected returns is that it involves risk. The higher returns are the reward for taking on risk. The difference between stock market returns and a safe investment like Treasury bills is called the “risk premium.”
The idea of market timing implies you can have the high returns from investing in stocks without taking on the risk. If it sounds too good to be true, it’s because it is.
Recessions and market crashes are a fact of life. It’s not a question of “if” you’ll experience a market crash. The only question is “how many” market crashes you’ll experience during your lifetime.
Remember, short-term pain is the price we pay for long-term gains and wealth building.
The risk of market timing
We already discussed the fairytale of market timing: you pull your money out right before the crash and get it back in the market before the recovery.
In reality, when many investors pull their money out of the market, they miss out on some of the market’s best returns.
Merril Lynch researched what happens when investors try and time the market. They examined the return on a $1,000 investment in the S&P 500 from 1989–2018 under three scenarios.
Scenario 1: The investor implements a buy and holds strategy.
Scenario 2: The investor pulls their money out of the market and misses the 10 best-performing months.
Scenario 3: The investor pulls their money out of the market and misses the 20 best-performing months.
The results demonstrate the risk of market timing.
The buy-and-hold investor ended with $17,306, a 1,631% return on investment.
The investor who missed the 10 best-performing months ended with $6,959, a 596% return on investment.
The investor who missed the 20 best-performing months ended with $3,328, a 233 % return on investment.
Volatility works both ways, there are periods of extreme negative volatility, but there are also periods of extreme positive volatility where the stock market goes through the roof in a very short period.
The risk of market timing is that you pull your money out, expecting the market to drop, and it soars upwards, and you miss out on those gains.
Successful market timing requires you to know two things
Exactly when to pull your money out of the market.
Exactly when to put your money back into the market.
The odds of you successfully timing the peak and bottom of the market are extremely low.
A more likely scenario is that you would sell too early and buy back too late.
Keep it simple, boring and profitable
Investing involves risk.
Trying to avoid this risk by timing the market simply opens you up to uncompensated risk. The risk premium for market timing is usually negative. Anyone who invests in the stock market needs to accept the fact that they will have years where their investments go down.
It sucks, but it’s the truth.
Charlatans will try to make money off you by telling you the convenient lie that investing can be painless—if you pay them for their advice. The hard truth is that investing can be very painful at times.
If you can’t accept that you are not cut out to be a DIY investor. There is no shame in that. It simply means you should hire a professional to help you manage your investments and avoid the temptation of trying to time the market.
Here’s a comforting fact; the stock market has always rewarded long-term investors who have what it takes to ride out the market crashes and bear markets.
Enjoyed this post? It was adapted from a chapter in my Book The Rational Investor, you can pick up your copy here.
(Paid subscribers can pick up their free copy here.)
This article is for informational purposes only. It should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any significant financial decisions.
Thank you for this post! One of my annoyances is investment newsletters persist and do well on Substack. Readers cannot parse credible writers from others. Keep at it!
This was useful, gave me food for thought, and helped me feel better about my strategy. Thank you.