Every investor has likely dreamed of being a successful market timer. In a year marked by the swiftest 30%+ decline in U.S. market history followed by the biggest 60-day rally in over 70 years, the appeal of being able to anticipate violent swings is probably stronger than ever. Unfortunately, not only is such timing very difficult to execute, but it is rarely a repeatable process. Those fortunate enough to forecast and profit from one major move in stock prices are not necessarily able to do it again the next time around. Even if able to beat the odds, there are still several reasons why the execution is so difficult.
Most investors trying to time the market are attempting to get out before things deteriorate with the idea of repositioning at lower prices. It sounds straight forward, but in this scenario the investor must be right twice. In reality, it is hard enough to be right once! Without the benefit of hindsight, distinguishing short-term blips from more severe downturns is challenging for even the most seasoned of professionals. As we have seen so far in 2020, sometimes even the most severe selloffs, the waterfall declines, only last a few weeks. But let us assume an investor can stick a favorable exit point. The exercise could be unproductive, if not outright harmful, and potentially expensive (in terms of capital gains taxes and transaction costs) if he fails to reposition.
Too many investors sell without clearly thinking through their criteria for reinvesting. The plan to “buy back in when things settle down” is flawed from the get-go. The stock market and the economy are rarely in synch and markets may move well in advance of actual economic improvement. The negative conditions that influenced the sell decision are likely to remain in place long after prices turn higher and the investor is certainly likely to feel less comfortable at the bottom than when prices were higher. Back tests and historical data identify the great entry points, but cannot recreate the angst and emotion of actually deploying capital during volatile periods. Even an investor strong in nerve and resolve can be paralyzed given the incredible speed of selloffs and recoveries these days.
The other challenge is that much of stock market return is often concentrated in a relatively small number of strongly positive days. Missing any number of these days over any given cycle significantly impacts performance. Most of the best days tend to cluster around most of the worst days, so if an investor is actually selling into the teeth of a pullback, the chances of missing some of these bounce back sessions are materially higher.
Investors would be wise to consider their time horizons and what they are trying to accomplish with a timing strategy. If the goal is simply to avoid or mitigate short-term market losses, yet the time horizon for the portfolio is still a number of years, then the exercise is likely not worth the execution risks.
Unsure where to start? By focusing on your unique situation and your goals for the future, we can help you develop a strategy for your investments.
Past performance is not indicative of future results and diversification does not ensure a profit or protect against loss. All investments carry some level of risk, including loss of principal. An investment cannot be made directly in an index.