Business Resources
Timing The Market
By Mary Shahian, Senior Vice President, Wachovia Wealth Management
Market timing is the strategy of buying or selling financial assets (often stocks) based on predictions of future price movements. Proponents of market timing suggest that technical and/or fundamental analysis can result in information that allows a trader to improve market returns above a buy and hold strategy. Arguments against market timing include the Efficient Market Hypothesis, which suggests that financial prices encompass all public information and that only new information can move prices. Most investors cannot predict the future direction of asset prices with any consistency.
Most investors tend to attach more significance to recent investment experience than to longer-term performance. Asset values are always changing and market cycles cause asset classes to come in and out of favor. Clearly there is an incentive to invest in the favored asset classes while avoiding the deteriorating ones. Unfortunately, academic research indicates that market timing generally provides little upside and may cause significant harm to an investment portfolio. According to the quantitative Analysis of Investor Behavior, 2007 by DALBAR, Inc., a study that reviewed investment flows into and out of mutual funds over the past 20 years, market timers performance was dismal when compared to the benchmark (buy and hold). In fact, DALBAR found that market timers in equity mutual funds accumulated an average return of 1.4% per year. Furthermore, evidence suggests that the average investor had likely succumbed to the lure of market timing, gaining annualized returns of only 4.48% over a period when the S&P grew by 11.81%. It appears, the study concludes, that victims of market timing seem to be the market timers themselves.
One reason that most individuals have difficulty timing the markets is that human nature makes it hard to be a pessimist at a market top (when everyone else seems to be an optimist) and an optimist at the bottom (when everyone else is negative). Rarely is the same investor able to effect buy trades and sell trades at the right times, because the fear that got the investor out of the market at the top is unlikely to turn into optimism when the markets themselves are most fearful.
Over time 80-90% of the gains from investing in stocks are realized on just 2-7% of trading days. That is a narrow window in which to be invested and large moves are often on the heels of significant downturns. In fact, some of the best days in the history of the markets were recorded right after the 1987 crash. Proponents of market timing, however, will note that on a similarly few days, the worst of the market’s returns are generated and being out of the market on those days affords huge gains over time. It is, however, impossible to know when those big down days will occur and an investor may be out of the markets frequently attempting to miss those days to the detriment of longer term returns. On the other hand, to achieve the good returns on the relatively few days when the market soars, an investor need only stay in the market.
The trading strategy that we advocate for most investors is to implement a simple rebalancing rule. An example would be a 5% threshold rule whereby the portfolio is rebalanced back to target weightings should any allocation within a diversified portfolio exceed +/-5% of the target weighting. Such a strategy forces the investor to take from the best performing assets and purchase the worst performing assets or, in other words, the investor is forced to sell high and buy low.
In order to employ this strategy, the investor needs a well thought-out, fully diversified approach to investing that is in line with his or her unique set of objectives. A fully diversified portfolio might typically include such asset classes as fixed income (both domestic and international), domestic equities, international equities and commodities, as well as domestic and international REITS. This strategy should be devised with the long term in mind and reviewed on a regular basis.
The asset allocation should be one that is comfortable in both good and bad markets. An individualized strategy should ideally be “all-weather,” a strategy utilized through changing economic climates, all the while attempting to address the apparent opportunities to mitigate near term risks. Over a full market cycle, investors can expect patience and discipline to be rewarded.
Past performance does not guarantee future results. The performance quoted represents past performance and current performance may be lower or higher. Investment return and principal value of an investment will fluctuate so that investor’s shares, when redeemed, may be worth more or less than their original cost. The information and statistics in this report have been obtained from sources we believe to be reliable but are not guaranteed by us to be accurate or complete. Any and all earnings, projections and estimates assume certain conditions and industry developments which are subject to change. The opinions expressed in this report are those of the author(s) and are not necessarily those of Wachovia Bank, NA or its affiliates. The material has been prepared or is distributed solely for information purposes and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy.
Securities and Insurance Products:
NOT INSURED BY FDIC OR ANY FEDERAL GOVERNMENT AGENCY • MAY LOSE VALUE • NOT A DEPOSIT OF OR GUARANTEED BY THE BANK OR ANY BANK AFFILIATE
Sources: Asset Allocation by Roger Gibson, Retirement Planning/November-December 1998, Fidelity, The Motley Fool, Profit From Market Timing by Rich Duprey, January, 2007, Market Timing and Roulette Wheels by Richard J. Bauer, Jr. and Julie R. Dahlquist, 2001, Association for Investment Management and Research, CNN Money, Market Timing Strategies That Worked by Pu Shen, Research Division, Federal Reserve Bank of Kansas City. DALBAR, Inc. develops standards for, and provides research, ratings and rankings of intangible factors to the mutual fund, broker/dealer, discount brokerage, life insurance and banking industries.
