Why timing the market doesn’t work

Market timing is an investing tactic where investors transfer their money in and out of the market in an attempt to avoid losses before they occur and buy-in at the bottom after the market has fallen. It’s the well known strategy of ‘buy low and sell high’.

It all sounds fine in theory, but timing the market seldom works in practice. Let’s go into why.

What goes wrong?

Market timing strategies are typically put in place when the market is high. People think that ‘what goes up, must come down’ so they panic. But there is also such a thing as momentum. If share prices have been climbing, they can continue to climb for some time.

The danger in trying to time the market is that you may sell too early and buy back in too late. This could result in your money being out of the market at the very time that it surges! It is virtually impossible to time the market correctly as no-one can precisely foresee future movement, so being out of the market for just a few days can have a devastating effect on returns.

Asset managers Schroders have researched the performance of three indices that reflected the performance of the UK stock market, the FTSE All Share, the FTSE 250 and the FTSE 100.

They found that if you had invested £1,000 in the FTSE 250 at the beginning of 1989 and left the investment untouched for the next 30 years, it might have been worth £26,831 by the end of that period (please note, past performance is no guarantee of future returns).

If, however, you had tried to time the market and missed out on the 30 best days, the same investment would have been worth £7,543 – a difference of £19,288 (with no adjustment for charges or inflation). Take a look at the different results:

• 11.6% per year if you stayed invested the whole time;

• 9.6% per year if you missed the 10 best days;

• 8.2% per year if you missed the 20 best days; and

• 7.0% per year if you missed the 30 best days

The difference in percentages might seem relatively small but when you take into account the compounding effect over the years, it becomes rather substantial.

Successful market timing is only possible if you know exactly when to pull your money out of the stock market and when to put it back in. And none of us has a crystal ball!

So why is it tempting?

Rationally, we know that it’s extremely difficult to time the market. We know that volatility is just part and parcel of investing. We know we should be in it for the long haul but it’s hard not to make a knee-jerk reaction, if we think the market is going to crash.

As humans we suffer from cognitive biases, one of which is loss aversion. We dislike losing more than we like winning. So if we look at the market and fear there is going to be a major downturn, it’s incredibly difficult to sit back and watch our hard-earned money disappear. Sticking to a long-term investment strategy takes self-control and courage.

We’re also prone to overconfidence. Even if we know deep down that market timing hardly ever works, we’re tempted to try and show otherwise. We’ll be the exception to the rule, we tell ourselves.

Time in the market

There is always going to be some risk in investing in the stock market. That’s why the returns are potentially greater than with something like government bonds. But trying to get around the inherent risk of investing through timing the market can open up even more risk.

The truth is that no one knows with certainty when the market will rise or fall and some years will inevitably be worse than others. The example above shows that time in the market is more important than timing the market. It’s far better to make a plan and stick to it, than to try to outguess the market, at least in my opinion.

If you’d like to discuss your investment strategy with us in more depth, do get in touch. You can call us on 01789 263888 or email hello@charterswealth.co.uk.

Please remember that past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amount originally invested.