The Perils of Market Timing

Missing just a few days of high returns in the stock market can substantially erode long-term performance.

The harsh reality of market efficiency has not stopped speculators and other traders from attempting to read the future. On paper, market timing offers a seductive prospect: By predicting market direction ahead of time, a trader might capture only the best-performing days and avoid the worst.

The first graph tells the other side of that story. Large gains may come in quick, unpredictable surges. A trader who misinterprets events may leave the market at the wrong time. Missing only a small fraction of days—especially the best days—can defeat a timer’s strategy.

 

For example, since 1970, missing the best 25 trading days would have significantly cut the S&P 500 Indexes annualized compound return. Trying to forecast which days or weeks will yield good or bad returns is a guessing game that can prove costly for investors.

This analysis offers further insight into the potential consequences of both successful and failed market timing.

The second graph plots the S&P 500′s annualized compound return since 1970. The brown bar (far left) shows what a buy-and-hold investor would have earned in annualized return for the entire period. The bars to the right show the incremental return impact if an investor had missed the best or worst day, month, quarter, or longer sequence during the period.

For example, the worst market day since 1970 occurred on October 19, 1987. An investor who avoided the worst day would have earned a 10.43% annualized return, but missing the best day would have reduced the return to 9.40%.

If daily market returns are random, market timing is a flip of the coin. Investors who attempt to predict market drops are just as likely to avoid them as to miss out on strong return periods.
 
 

Disclosures: This blog is intended to provide general information only and should not be construed as an offer of specifically tailored individualized advice. Please contact Independence Advisors, your accountant and/or attorney for advice appropriate to your specific situation.

Investing in any security, including mutual funds and ETFs, involves a risk of loss of both income and principal.
This blog may include forward-looking statements. All statements other than statements of historical fact are forward-looking statements (including words such as “believe”, “estimate”, “anticipate”, “may”, “will”, “should”, and “expect”). Although we believe that the expectations reflected in such forward-looking statements are reasonable, we can gove no assurance that such expectations will prove to be correct.

About Chas Boinske

Charles P. Boinske, CFA, is a 30 year investment management veteran overseeing the strategic direction and portfolio management process for Independence Advisors, LLC. Have a question for Charles? CLICK HERE TO ASK CHARLES

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