Market Timing Tip - Don't Do It
There is only one tip with regard to market timing - don't do it! Really...don't do it! I want to drive the point home...there is no way to successfully time the markets in the long run. Market timing is when you try to get into stocks or some segment of stocks before they go up and/or try to get out before they go down. Unfortunately, the results are typically just the opposite for most people. Trying to be active, beat the markets, and spot patterns ends up costing us dearly.
I know people who were ignoring certain aspects of the stock markets, because they haven't been performing well lately, and they were afraid they would continue to do poorly. An example of this is the stocks of companies in emerging market countries, like China, Russia, Brazil, and India. On the flip side, I know people who went "all in" emerging markets stocks for exactly the same reason, for fear of missing out on the enormous upside potential. I know people who got out of the stock markets right before the 2012 presidential election because of fears of of Obama winning. I know people who are in cash right now because of fears of what Trump might do. I know people who sold their investments in 2008 for fear that they would go to zero.
The Appeal Of Market Timing
I get why it's very appealing to think that we, or someone on our behalf, can get us out of the stock markets before something scary happens. We also want to be able to get back in before we miss out! This is an emotional issue, not a logical one. Most of us know that if we invested our money and then forgot about it for 30 years that we would be very happy with our results. Unfortunately, the financial circus (i.e.the financial media) make a lot of money by convincing us that we have to pay attention every minute of every day, and suggesting that we should do something...anything.
Why It Does Not Work
Professionals do the trading: When you go to buy or sell a stock, an ETF, or a mutual fund, you are placing a trade. I know "trading" sounds like someone sitting in front of nine screens looking at charts and news, because that's how we've been trained to think about trading. But you are a trader if you buy 100 shares of Apple. Now, the scary thing is that a vast majority - 90-95% (some research suggests as high as 98%) - of all trading is done by professionals. Professionals are those who work for hedge funds, mutual funds, pension funds, investment management firms, and insurance companies. That means, that when you buy your 100 shares of Apple because you think the price is going up, a professional sold those shares to you because they think the price is going down. Now, professionals aren't always right, but you have to ask, if you are buying or selling into our out of a stock market segment, are you more likely to be right than a professional, with their resources and technology?
The news is reflected in the price. When you read in the paper or hear on the news that something happened in the economy or with a particular stock, it's far too late for you to make any money because of that news. Everything that has ever happened and everything that is likely to happen is already factored into the prices of stocks. That means that the prices of stock markets (which are aggregates the price of each stock) only change with new information, and new information is random.
You have to be right twice. Now that we know that it is very, very difficult (read: impossible) to know when the stock markets will turn, I'll now drop this bomb - to correctly time the markets, you have to be correct twice. You have to know when to get out, then when to get back in. Some research suggests that you actually have to be right three out of four times in order to do better than just staying the course. I wouldn't bet on those odds!
You can't miss the up days. About half of the long term returns of stock markets come from just a few very large trading days. You can't afford to miss these. If you miss just the ten largest days in the stock markets it costs you close to a quarter of the overall return. You need to be invested at all times to capture the returns that stock investing offers.
Are We In A Down Market?
What makes this process even harder is that we don't even know if we are currently in a down market (or if a segment of stocks is in a down market). It is very easy to see, with hindsight, that there was a down market, but you can't tell while you're in one. Even in the worst of down markets, about a third of the months end with positive returns. Stock market returns are positive in the long term, but random in the short term.
What Do You Do Instead?
The amount of ground gained in the stock markets has always been more than sufficient to make up for losses in down markets. Remind yourself that when the prices of stocks go down, that just means that the prices of the companies you own have gone down; but you still own those companies. These temporary losses are made permanent by selling your shares to someone at the lower prices. Learn from investing history. Go back and read headlines from late 2007 to early 2009, early 2000 to late 2002, or August 1987 to December 1987. Realize that things are going to seem very scary, but also realize that you are going to be okay.
I know you are going to be okay because you are also going to calculate the money you need to withdraw from your investment accounts (if any) in the next five years, and you aren't going to invest any of that money in the stock markets. You are also going to be really honest with yourself about how much you pay attention to the financial news and how it will affect you. If you get nervous and can't sleep, put less of your money in stocks. If you recognize that down markets are a great time to buy more, you can handle more of your money in the stock market. Then you have to behave...for a really long time. Remember why you are investing in the first place.
There is a quote I like by author Charley Ellis, author of Winning the Loser's Game, "The real opportunity to achieve superior results is not scrambling to outperform a market, but in establishing and adhering to appropriate investment policies over the long term - policies that position your portfolio [collection of investments] to benefit from riding with the main long term forces in the markets."
Another great quote is from Jonathan Clements, who used to write a personal finance column for the Wall Street Journal, "Don't ask, 'Will the stock market crash?' Instead ask, 'What are the consequences if it does?'"
