October 31, 2024

Why ‘timing the market’ doesn’t work

Timing the market is near impossible. Here we explore why and discuss what we believe is a better approach when it comes to successful investing.

It’s a question investors commonly ask, ‘can you time the share market?’ To come to the point quickly, no, it’s simply too hard to do. And all the data seems to agree.

What is ‘market timing’? It’s an approach that involves making investment decisions based on short-term market movements. For example, scooping up the bottom of the share market barrel hoping to take advantage of any following rebound – or selling when the market suddenly drops.  

In contrast, we believe a buy-and-hold approach is the way to go. This involves buying shares and holding them over the long-term, despite whatever the market may be doing. In fact, there is a great body of research supporting the idea that this passive buy-and-hold, long-term approach to owning shares produces better long-term results.  

Our Investment Manager, Betashares, has done the maths using the S&P/ASX 200 benchmark index, to show just how big a difference it can make when investors miss out on just a handful of the biggest market rallies:

Betashares' graph:

Those who attempt to ‘time the market’ are likely to miss out on some of the market’s biggest rebounds. Humans have a tendency towards loss aversion (we typically try to avoid loss), which can cause investors to panic, throw their strategy out the window and sell when the markets sour. However, this can be the worst time to sell, as the biggest market rallies can occur in the middle of major market falls. And the more of those rallies you miss out on, the lower your gains will be over the longer-term.  After all, the 20 biggest 1-day rallies have occurred after a major fall. Here’s a chart from Betashares depicting these major market rebounds and crashes:

In contrast, by staying invested in the benchmark share market index, you would automatically capture all market movements (both negative and positive), which over time could prove advantageous.  

For example, consider a hypothetical investor who sells a $10,000 investment that provides exposure to a broad share market index during the March 2020 market downturn caused by Covid. From 20 March 2020 to 5 August 2024, the ASX 200 returned 58.8%, which would have resulted in a $5,880 return on the initial investment of $10,000. Over the same period, the S&P 500 returned 125.01% and the Nasdaq 100 returned 155.85%, which would have resulted in $12,501 and $15,585 in returns respectively. These return figures assume reinvestment of any dividends from the relevant holdings.  

The hypothetical investor who sold their investment and stayed out of the market from that point until now would have forgone thousands of dollars in potential gains from the recovery that followed.

Independent research points to the same result

A recent paper from JP Morgan, ‘Is market timing worth it during periods of intense volatility?’ revealed that timing the market is almost impossible to achieve given that good and bad trading days fall so closely together.1

As at the end of 2021, seven of the best days in the US had occurred within two weeks of their corresponding worst day; but often the gap between the best and worst days was much shorter.

For example, March 12, 2020 was the second-worst day of the year in US share markets, yet that was immediately followed by the second-best day of the year.

JP Morgan’s study found that the worst days overwhelmingly occurred before the best days: over the last 200 years, six of the seven best days occurred after the worst day.

The close proximity of the best and worst days makes it virtually impossible to buy shares at the bottom before they climb again as most people are not that quick or lucky.

In other words, it’s very unlikely that an investor could be lucky enough to consistently miss the worst days while being invested in the market for the best days.

JP Morgan’s final thought is this: ‘It is important to remind investors that success is achieved through time in the market, not timing the market. And, to quote Dolly Parton, ‘If you want the rainbow, you gotta put with the rain’.’

And we’d have to agree.  

The pain of missing out

Other research from the Schwab Center for Financial Research, ‘Does Market Timing Work?’ found that even badly-timed stock market investments were much better than having no share market investments at all.

This is because investors who procrastinate and don’t act are likely to miss out on the stock market’s potential growth.

‘Procrastination can be worse than bad timing. Long term, it’s almost always better to invest in stocks – even at the worst time each year – than not to invest at all,’ according to their research.

If you don’t have a large single sum to invest or like the discipline of investing small amounts regularly, then dollar-cost averaging can assist in mitigating market timing risk and can help you gradually accumulate wealth.

Similar to a regular savings plan, dollar cost averaging involves investing the same amount of money at set intervals over a long period – whether market prices are up or down.

The key takeaway

It’s almost impossible to time the market consistently whether it’s over a short-term time frame or over the long term.

Instead, investors should consider having a well-diversified portfolio and holding it over the long-term.

At 5 Financial, we help clients build a well-diversified share portfolio in line with their goals and risk tolerance. Taking a long-term approach is at the heart of our investment philosophy, and we are less concerned about weathering the daily ups and downs inherent in trading – as we are about the overall wealth growth produced over years of investing and re-investing.

If you’d like to speak to one of our expert Financial Advisers about building an effective portfolio, call (02) 9739 6555.  

This article is an adaptation from an article from betashares.com.au.

Please note, the above information does not constitute financial advice and does not take into account your current circumstances or goals. Please speak with a Financial Adviser before acting on any information found here or throughout the 5 Financial website.

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