While I have mentioned the failure of market timing on many occasions in the past, it bears repeating. Market timing does not provide a good foundation for an investment strategy. Markets are too efficient to allow market timers to reliably forecast the future. In short, market timing offers false hopes to investors.
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 chart below 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.
Further analysis gives insight into the potential consequences of both successful and failed market timing.
The graph below plots the S&P 500′s annualized compound return since 1970. The orange 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 10.36% annualized return, but missing the best day would have reduced the return to 9.51%.
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. For the vast majority of investors, it makes sense to diversify broadly, keep an eye on costs, watch taxes, stay disciplined and ignore the false hope of market timing.