Market timing is one of the most seductive notions investors have to contend with. How hard can it be, we ask ourselves, to sell when the market's high and about to fall, and buy back in just as it hits the bottom and is set to rise?
The answer, alas, is that it's very hard to do, at least with any consistency. It seems so obvious, with the benefit of a hindsight, that past stock market crashes occurred when they did. But recognizing, in real time, that markets are about to tumble is much more challenging than most people think.
Remember, too, that successful market timing also requires you to time your re-entry correctly. Most of the gains in the stock market occur over very short periods of time, and if you’re not in during those times, you don’t get the gains. The problem is, no one knows when those days occur. To quote Charles Ellis, “You have to be there when lightning strikes. That’s why market timing is a truly wicked idea. Don’t try it."
Throughout our investing lives we are constantly tempted to act irrationally. A prime example is picking stocks. So, for example, we’ll hear from our brother-in-law or a friend at work about a stock that’s tipped to soar in price and instinctively want to buy it. Or we’ll read in the papers about a fund that’s vastly outperformed the market over the last 12 months and decide to invest in it.
Unfortunately, picking stocks is a losing strategy. You’re better off investing in the whole market, via low-cost index funds, instead. Trying to identify, in advance, funds that will outperform, is another fool’s errand. In the long run, only a tiny proportion of active fund managers beat their respective benchmark on a properly cost- and risk-adjusted basis, and picking those very few winners before they start to outperform is all but impossible.
Another big temptation is to try to time the market. There are always pundits in the media saying that now is either a good time or bad time to invest in stocks or bonds, or in specific countries or sectors of the economy. Because of our evolutionary make-up, and particularly our desire to make sense of the world and to feel we have a degree of control over events as they unfold, we want to believe them. We’re attracted by seemingly convincing narratives, and, because of our innate negativity bias, we pay a disproportionate amount of attention to pessimists and doomsayers.
This article is based on the book Index Funds: The 12-Step Program for Active Investors. The issues it raises are addressed in Step 4:
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