Is it possible to know when to be invested in the market and know when to get out of the market? Those who attempt to get in and out of the stock market are referred to as active investors or active money managers. This type of management is called market timing.
The definition of market timing is any attempt to alter or change the mix of assets based on a prediction or forecast about the future. The myth is that active money managers are able to utilize market timing to effectively predict up & down markets. The problem is this may result in missing not just down days but some of the best (most bullish) days in the markets as well. This mistake can be very hazardous to your wealth!
Missing even five of the best days of the market can have a substantial impact on a portfolio as you can see by the next chart.
Missing just five of the best days would have cut your returns by almost half. No one knows when those “best days” will happen.
Dalbar, Inc. conducted a study of individual investors over a period of twenty years. From the twenty-year study, we learn the following:
As the chart clearly indicates, the average active investor only earned an average of 3.17% while the S&P 500 averaged a significantly higher return.
According to Dalbar, the average investor’s holding period was only slightly more than 3 years for the twenty-year period covered by the study. That means they were jumping in and out of the market at the wrong time. They were trying to attempt to “time” the market. Investors that time the market actually lose money over the period measured.
It isn’t difficult to see that market timing is a very risky proposition when it comes to building wealth. Being out of the market is simply too big of an opportunity cost.
Charles D. Ellis, a managing partner of Greenwich Associates, the leading consulting firm specializing in financial services worldwide, wrote a book which was required study material for investment advisors. He said, “The evidence on investment managers’ success with market timing is impressive, and overwhelmingly negative.” It is impossible to know the best and worst days to invest. The simple solution is to always be invested. That is the only way to avoid missing the best days.
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1 Source: ChartSource, Standard & Poor’s Financial Communications. Stocks are represented by Standard & Poor’s Composite Index of 500 Stocks, and unmanaged index that is generally considered representative of the US stock market. Past performance is not a guarantee of future events. Based on investment of $10,000. January 1, 1970 – December 31, 2009
2 DALBAR study, Quantitative Analysis of Investor Behavior, 03/2010