Market Timing – Why It Does Not Work and How to Avoid It

Market timing does not work. Many people attempt it. Some are taught a lesson. Others get lucky for some time, but usually are eventually taught a lesson.

Before we start with market timing, we can look at the parallels between driving and market timing.

Have you ever been driving on the freeway, traffic starts to slow down, the car behind you pulls out of your lane to what appears to be a faster lane, that new lane slows down, and then they try to get back in your lane? They continue to swerve between lanes, always chasing the one that appears to be faster, but it almost always puts them behind you. 

Meanwhile, you continue in your lane, amused by this person’s foolish actions, and watch them stressfully and unsuccessfully go in and out of the lanes, only to end up stuck behind a long line of traffic as you cruise by. 

We all have likely watched it. We all also have likely done it ourselves. 

Most of us learn it’s impossible to swerve in and out of traffic as it slows down and pass ahead of everybody else. Occasionally, you get lucky and choose a lane that puts you ahead, but it’s rare. The next week, you can try the same thing and get stuck behind a long line of traffic. 

Market timing, the decision to move money in and out of the stock market or among different investments by attempting to predict future prices, is the same way. 

Research has shown it’s impossible to consistently and successfully time markets. Yes, there are outliers, such as Renaissance Technologies’ Medallion Fund, which is a hedge fund that has averaged 66% annual returns between 1988 and 2018. These types of stories are exactly why people attempt to time markets. The lure of outrageously high returns and avoiding negative returns chip away at our emotional side. They welcome extreme risk-taking and silly behavior. 

Many people attempt to time markets, selling stocks before the “next big crash”, buying the “next Amazon”, or “holding cash because the market went up too much.” 

Overwhelmingly, most people who attempt to time markets end up less wealthy than people who simply and consistently invest in the stock market and never sell. 

Let’s explore why market timing does not work, common reasons why people do it, and the ways you can combat your natural behavior to want to try it. 

Why Market Timing Does Not Work

The stock market is very volatile. If you looked on any given day, it could be up, down, or flat. On a day-to-day basis, it’s very volatile; however, if you look at 5-year, 10-year, and longer periods, the returns tend to converge on a fairly narrow range. 

Look at the chart below showing the largest decline and total return for the US Stock Market by year. In most years, you’ll experience a sizeable decline; however, you’ll also experience a gain in most years. When you see the positive returns in green, why would you ever bet against the stock market?

Intra-year declines and total return - why market timing does not work
Market timing difficult with market volatility
Source: Franklin Templeton

How would you time the market seeing the fluctuations above? Even if you knew exactly what was going to happen, you have no idea what events would follow or how the market would react. 

For example, if I told you there would be a global pandemic where countries shut their borders, supply chains disrupted, and economies basically shut down for a couple of months, would you guess the market would be higher a year later?

Of course not! Nobody did.

Except, that’s exactly what happened. Trillions of dollars were poured into the economy by the government and the Federal Reserve cut interest rates to stimulate growth. Who saw that happening? We experienced the largest stimulus package in history – dwarfing the Financial Crisis of 2009 stimulus by more than double. 

The point is people like to say if X happens, Y will happen. If the world experiences a shutdown, markets will be lower. But, that’s problematic. 

If the world experiences a shutdown, stimulus may be passed, and that stimulus may be spent or saved, which could increase or decrease spending on real estate, which could increase or decrease buying, which could increase or decrease _____________ (fill in the blank yourself). 

The world is not linear. It’s a bunch of connected squiggly lines intersecting other lines. It’s messy. It’s not clean. 

People want an easy story for why markets go up or down on a daily, weekly, or monthly basis. And, the explanation given sounds confident and intelligent, but very few people can time markets consistently and successfully.

Besides, ask yourself, “Can I outperform PhDs and professionals who have access to the best data, fastest computers, and who dedicate their entire lives to investing?” I know I can’t. Can you? 

The other issue with market timing is that it is not one decision. It’s being right about every decision. You need to precisely time your sale and buy – every single time. For those who sold in March during COVID, they missed 60%+ returns from the bottom. They may have looked like a genius when the market went down about 30% in the span of three weeks, but now they look foolish. 

They may spout off about the Fed interfering with markets or politicians spending money the US does not have, but it does not matter. The fact of the matter is that it happened, and for those who held a globally diversified portfolio through the fluctuations, they are better off than before the pandemic. 

If you want to time the market, you need to be right every single time. It only takes one wrong action to either significantly lower your long-term return or blow up your investment plan. Returns come in spurts, and missing one can damage your long-term plan. In other words, it’s best to take the bad with the good. If you try to avoid the bad, you’ll miss out on too much of the good. 

Do you have the confidence, willpower, and foresight to consistently know when to buy and sell? 

Research says no. Remember, you may get lucky here and there, but it only takes one wrong move to get burned and learn your lesson. 

Another reason market timing does not work is that our emotions don’t serve us well. We are naturally wired to be bad investors. When markets go down and flash red, that is a sign to retreat, to do something different. We experience fear and stress, which are helpful emotions in most other areas of life, but with investing, they are not. 

Investing should not be emotional. It should be boring. That’s why investment plans, which I’ll talk about later, are critical. They tell you exactly how you should behave in different scenarios. It’s like practicing for a fire drill. If you practice, you know exactly what to do if you ever experience a fire. 

The only difference in investing is it is far more likely you’ll go through a decline regularly. It would be as if you had an actual fire every year, sometimes multiple times per year. 

Lastly, if market timing worked, everybody would be rich. The people who claim to have created the perfect strategy to time in and out of markets and buy the next big investment would not be selling you a course or subscription, and would not be investing your money for fees. They would be retired or doing something else because they would have more money than they know what to do with. 

One final thought on why market timing does not work – for those who are attempting to sell to avoid downfalls or think the stock market will collapse permanently, they are betting on something that has never happened. There have been huge declines throughout history, but a globally diversified portfolio has always recovered.

Now, you may be asking, “What if this time is different? What if it permanently collapses?” 

I don’t know, but I am betting if that happens, nobody is going to care about money. They will likely only care about food, water, shelter, and other basic needs to survive. I could be wrong, but it’s hard to picture a world where markets collapse permanently and people are trading gold or other investments.

If you remember only one saying, remember this one: “It’s time in the market – not timing the market.” 

Common Reasons People Attempt Market Timing

If market timing does not work, why do people attempt it? 

The lure of winning and super high returns. 

Imagine if you could experience every positive year in the stock market and avoid all the negative ones. You would be incredibly wealthy. You would have bragging rights among your friends. You could sell your strategy to others. The possibilities are endless. 

People are attracted to money and, as I discussed above, our emotions normally do not serve us well when investing. 

We get greedy. We chase what worked. We lay out an easy explanation connecting all the dots. We tell ourselves stories. 

Look at the chart below and imagine trying to avoid all the shaded areas, the negative returns, in the 1-year horizon. You would be stressed and create many opportunities for error.

Instead, what if you focused on the 10-year horizon and the positive return blue areas? All you needed to do was stay invested to earn those returns.

1-year horizon investing vs. 10-year horizon
Source: JP Morgan – Investing with Composure in Volatile Markets

The other reason people attempt market timing is that they are short-sighted. Most people want instant results. They want to think they can control their own outcome, but with investing, you can’t. 

Most people are used to the fact that if they work hard, they can earn more money, promotions, or prestige. Investing is the opposite. The more you fiddle with it, the worse the outcome normally. 

Unfortunately, many people have not learned that or have forgotten. 

Remember, your emotions likely will get in the way of your investing. It’s one of the common reasons people attempt market timing. 

How to Avoid Market Timing

If you know market timing does not work and why people attempt it, how do you avoid it? 

There are three main ways to avoid market timing:

  1. Have an investment policy statement
  2. Work with a financial planner to handle your investments
  3. Accept you will market time and limit your exposure

Have an Investment Policy Statement

An investment policy statement is a fancy way of documenting a set of rules you will follow. In it, you will document your goals, what strategies you will use, your asset allocation, risk level, cash needs, and other guidelines. 

You can read a great article describing them in more detail. They even include a sample investment policy statement you can use to draft your own. 

Like I mentioned earlier, you practice fire drills as a kid in order to know exactly what to do in the event of a fire. Your investment policy statement is your fire drill. It will tell you exactly how to behave during nearly every situation. You simply need to follow the rules. 

This works because, instead of making rules as you go through a market decline where your stress levels are running high, you have already methodically created a plan for that exact situation. 

Work With a Financial Planner to Handle Your Investments 

If you are the type of person who knows you will not handle market declines well or be tempted to chase the latest investment craze, you can outsource your investments. Although there are many bad financial planners, there are also many very helpful, ethical ones, too. I won’t go into detail about how to find one because that could be more than one article, but hiring a professional is a good solution if you don’t have the time, experience, or dedication to creating a successful investing experience for yourself. 

Accept You Will Market Time and Limit Your Exposure

Lastly, accept you will market time, but limit it to a certain portion of your portfolio. For example, instead of saying 100% of your portfolio can be allocated to your market timing attempts, give yourself 5% of your portfolio for it.

For example, if you have $10,000, put $9,500 of it in a long-term strategy and market time with $500. When the $500 is lost, that’s all you get, unless you add additional money to the portfolio and limit it to 5% again. If the $500 grows to more than 10% of your overall portfolio, sell part of that portfolio, and put it into the long-term strategy. 

It’s okay to take risks and have some fun money, but most of it should be following a disciplined approach. 

I’ve also heard others suggest doing something else risky with the money. You could go to Vegas or your local casino and gamble with it. You could spend it on a risky activity, like rally racing or skydiving. Anything to get your adrenaline going and create a similar experience to market timing. 

Personally, I limit myself to what I call “one or two stupid trades” per year. This is my way of keeping the bulk of my portfolio in boring, diversified investments. Since I know I get one or two stupid trades that make up a tiny fraction of my overall net worth per year, I can stay disciplined with the bulk of my money, but still boost my adrenaline and have a little fun each year with those speculative trades. 

For me, it’s a good trade-off. It does not work for everybody. You know yourself best – pick one of the three options that will help you avoid market timing. 

Summary – Final Thoughts

Despite overwhelming evidence market timing does not work, people attempt it every day. Like drivers, they attempt to swerve in and out of lanes chasing the next best thing. Worse, if they get lucky and are successful, they mistake it for skill, reinforcing the bad behavior until one day it hurts them.  

Emotions often get in the way of successful investing. Market timing is attractive because it promises all the good positive returns without the bad negative ones. If the story is too good to be true, well, you know the rest. 

Preventing yourself from market timing does not need to be complicated. There are three good strategies and you can use each one independently or combined with others. Every investor should have an investment policy statement, but in addition, you can hire a professional or allocate a small percentage of your investments to a market timing strategy. 

What steps will you take to avoid market timing? 

Disclaimer: This article is for general information and educational purposes only and should not be considered investment, financial, legal, or tax advice. It is not a recommendation for purchase or sale of any security or investment advisory services. Please consult your own legal, financial, and other professionals to determine what may be appropriate for you. Opinions expressed are as of the date of publication, and such opinions are subject to change. Click for Full Disclaimer