Time in the market vs Timing the market

By | CYH

The finance industry likes to remind clients that ‘time in the market’ is more important than ‘timing the market’.

This is one of the dangerous half truths that harms investors when taken out of context.

The common statistical argument for time in the market is that if you miss the ‘best days’ in the markets, your returns will suck.

This is true. Based on a research by University of Michigan, a buy and hold strategy will yield 10.84% per year (between 1963 to 2004). But if an investor tried to time the market and missed the best 90 trading days, the returns dropped to 3.2%!

Hence the financial advice is to stay invested, or ‘time in the market’, so as not to miss the best days.

But the advice usually omit the fact that if you miss the worst days, your returns are even better.

In the same study, missing the worst 90 days would result in achieving 19.57% return per year over the same period!

So missing worst days are better than investing through the best days. In this case, ‘timing the market’ pays better than ‘time in the market’.

Of course the financial industry has vested interest. Majority of the fees are charged based on the value of managed assets. ‘Timing the market’ is disruptive to their revenue. ‘Time in the market’ provides steady fees.

To be fair, timing the market is not easy. Mistiming the market can cost a career and hence very few finance professionals dare to risk it. And the chances of mistiming are high.

Thus, staying in the market is an easier and safer task.

There are indeed situations whereby time in the market are preferred – well-diversified investments such as an index fund or growth stocks.

Indices generally go up over the long term due to GDP growth and inflation. But of course there are caveats – not all country indices go up in the long term – ask the Japanese. But generally most developed markets do.

As for growth stocks, time in the market is important because you need time for compounding effect to take place.

For other situations, timing the market are more important. The most obvious is when you use technical analysis to decide your trades. It could be swing trading or momentum, there is a time to buy and sell.

Similar for value stocks. These are not the best companies and may not do well over the long term. The profits come from heavy mispricings and not due to growth. – buy when the price is overly discounted and sell when the price rebounds. Value stocks have to be timed.

The worst is when investors abuse the ‘time in the market’ advice. They bought a stock and the stock price declined. Deep down they knew they have made a mistake but it is too painful to realise the loss. So they hold the stock and tell themselves they are long-term investors.

Unfortunately most stocks cannot last the test of time and hence time in the market becomes harmful. Time will not heal the wounds because these stocks may not return to the price they bought.

Time in the market doesn’t cure all your mistakes.

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