Timing the Market

"Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves." - Peter Lynch

This week I would like to discuss a topic that comes up frequently in the world of investing – timing the market. Every investor has felt the temptation of timing the market at some point:

“Should I invest now or wait for the next correction to jump in?”
“What if I invest and the market tanks?”
“This gold-guy on talk radio says that another crash is coming, maybe I should buy his book?”

Charles Schwab produced a great article on market timing here. In the article, they examine five investors each with their own investing approach. Each investor received $2,000 at the beginning of the year, for 20 years, ending in 2012. For Schwab’s example, the investors all invested in the same S&P 500 fund. Here’s how the investors’ strategies differed:

Peter is one of the greatest investors of all time. He was able to invest his $2,000 at the lowest monthly close of the year, each and every year, for 20 years. With his amazing market timing abilities, he was able to pick the most advantageous moments of the year to invest.
Ashley took a simpler approach – she invested the $2,000 as soon as it hit her bank account each year, without regard for market conditions.
Matthew divided his $2,000 into 12 equal amounts, and invested one portion per month at the beginning of each month continuously for 20 years. This is a strategy commonly known as dollar-cost averaging.
Rosie has incredibly unlucky timing. She invests her $2,000 at the market peak each year, the opposite of Peter. She buys when the price is high as often as possible.
Larry left his money in cash (using Treasury bills as the investment) because he was constantly waiting for the next great market crash. Larry invested none of the allocated money in the stock market for 20 years.

When we examine the results after 20 years, things get interesting. Peter naturally comes out ahead accumulating over $87,000. Ashley and Matthew, however, are not far behind - their simple approaches performed admirably. Peter’s perfect timing only accumulated $5,000 more than Ashley and Matthew.

Even Bad Market Timing Trumps Inertia

My favorite takeaway, however, is the fact that Rosie (the world’s unluckiest investor) still performed well, and built substantially more wealth than Larry (who stayed out of the stock market completely). By waiting on the sidelines, Larry sacrificed over $21,000. Even an investor with the world’s worst timing outperforms the one who doesn’t invest at all.

Source: Charles Schwab. Hypothetical $2,000 annual investments in S&P 500 Index. The individual who never bought stocks in the example invested in the lbbotson U.S. 30-day Treasury Bill Index. Past performance is no guarantee of future results. Indexes are unmanaged, do not incur fees or expenses and cannot be invested in directly. The examples are hypothetical and provided for illustrative purposes only. They are not intended to represent a specific investment product and investors may not achieve similar results. Dividends and interest are assumed to have been reinvested, and the examples do not reflect the effects of taxes, expenses, or fees. Had fees, expenses or taxes been considered, returns would have been substantially lower.

Chances are you have seen an article like this before, and studies like this are not new or groundbreaking. If we’ve all read the articles and studies, why do we still try to time the market?

The psychology behind wanting to time the market can come from a number of experiences, but I will draw from my own personal investing experience. To be a successful investor you have to be able to avoid the natural human tendency to follow the herd. While it seems simple, this is incredibly hard to do. As humans, our brains are wired to follow other humans; centuries of evolution have taught us that there is safety in numbers. We are pack animals, and it is natural for us to follow the crowd.

The Wall of Worry

The stock market climbs what is called “The Wall of Worry.” We may not realize that the wall is there, but it is a perpetual enemy of every investor. Essentially, the “wall of worry” alludes to the fact that there is always something to be worried about when it comes to investing and economics. This week it is the possible slowdown of the Chinese economy and what the Federal Reserve plans for interest rates. Before that it was Greece’s economic woes and Ebola. Before that it was Russia invading Ukraine and the threat of a U.S. government shutdown (does anyone even remember that?). The list goes on and on – I’m sure you see my point.

Recency bias is the tendency for our brains to be on the lookout for whatever has greatly affected us recently. The 2008-2009 financial crisis was devastating to many investors, and our brains are now more likely to be on the lookout for the next one. When you examine the financial crisis through the lens of market history, however, it is not a very common market event. When you combine the perpetual “wall of worry” with the natural cognitive bias of recency bias, it becomes a recipe for desire to time the market.

It is completely human and natural to want to try to time the market, but research demonstrates that it is not the most important factor to successful investing. I’ve always found this statistic fascinating: 95% of the market gains between 1963 and 1993 stemmed from 1.2% of the trading days. In other words, if you had your money on the sidelines during the 90 best-performing days of the stock market (1.2% of the time) during that time period, your average annual return would have dropped from 11% to a little more than 3%. Those statistics show that time in the market is more important than timing the market.

These studies helped me form our core investing philosophy at Fairlead Financial Group. It is one of the reasons I emphasize focusing predominantly on variables within our control. It is much more advantageous to focus on variables like what investments we own, how much we save, and how much we are paying in fees and taxes than it is to focus on timing the market, predicting global events, or guessing when the next government shutdown will be. I hope this blog post will help investors place less emotional energy into timing the market and more on developing their goals and financial plan. By focusing on your goals and your plan, climbing to the top of that wall of worry we talked about becomes simpler.

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