Profit From Market Timing

Have you ever seen (or been one of) those crazy shoppers jumping from line to line at the supermarket checkout, looking for the shortest one? The funny thing is: They tend to settle on the slowest line anyway.

Unfortunately, that's how some people approach investing. They jump in and out of stocks, looking for the one that will make them the largest amount of money in the shortest amount of time. They're racing to a finish line that's not there.

You gotta be in it to win it
Between 80% and 90% of the returns realized on stocks occurs between 2% and 7% of the time. So, if you're out of the market when stocks make their move, your portfolio is doomed to underperformance.

For example, 1974 was not a good year to own Coca-Cola (NYSE: KO  ) shares. It opened the year at $126 and by October had lost 63% of its value, falling all the way to $47 a pop. Had you the fortitude to hold on, however, today those same shares trade at almost $49 a stub -- after five separate share splits. In other words, patient investors are looking at a total return of more than 12,500%.

Check out the returns on these few stocks if you'd held them close and not been tempted to sell.

Company

High Price

High-Price Date

Low Price

Low-Price Date

Recent Price

Johnson &
Johnson
(NYSE: JNJ  )

$3.11

Jan. 1983

$1.88

July 1984

$67.18

JPMorgan (NYSE: JPM  )

$10.25

Jan. 1989

$5.17

Oct. 1990

$49.66

Chevron (NYSE: CVX  )

$5.00

Jan. 1973

$2.78

Dec. 1974

$71.22

All share prices are split-adjusted. Recent Price data as of market close Jan. 22, 2007.

It's a story that's played out again and again.

Need more?
Between 1986 and 2005, the S&P 500 compounded at an annual rate of return of 11.9% -- even while facing market booms and busts, war, 9/11, constitutional crises, and more. Over that 20-year period, $10,000 invested in the index would have grown to $94,555. Yet a recent report by Dalbar shows that the average investor's return during that time was only 3.9% (so that $10,000 grew to just $21,422). The reason was simple: market timing.

When the market crashed in 2000, billions of dollars were pulled out of the market. Now, a full seven years later, some investors are just getting back in. Admittedly, it wasn't an easy time to sit tight. When markets turn dark, investors are unwilling to commit to buying stocks even though it's when some of the greatest profits can be made.

Being greedy when others are fearful
One of the early stock recommendations David Gardner made at Motley Fool Stock Advisor was Marvel Entertainment (NYSE: MVL  ) , buying it at the split-adjusted price of $3.47. He watched as it dipped as low as $2.66 a share (split-adjusted) in the following months, but instead of bailing out, he held tight. Today, Marvel sells for $28 a share, a greater-than-700% return.

David's brother Tom had a similar experience with Corporate Executive Board (Nasdaq: EXBD  ) , his July 2002 Stock Advisor recommendation. After buying it for $28 a share, he watched it fall more than $3 but held on. Today, it trades for nearly $90.

The lesson here: No one can consistently pick a stock's top or bottom.

Time in the market, not timing the market
It's not timing the market that's key, but rather the amount of time you're in the market. Using data from Bloomberg, American Century Investments looked at the period from 1990 to 2005 and found that a $10,000 investment would have grown to $51,354 had you just sat tight from beginning to end. However, if you had missed the best 10 days in that 15-year period, your returns would have dwindled to $31,994; if you had missed the best 30 days, you'd be looking at a mere $15,730.

Nobel laureate William Sharpe found that market timers must be right an incredible 82% of the time just to match the returns realized by buy-and-hold investors. While long-term investors were sitting tight, the market timer was fretting over when was the best time to get in or out of the market and not necessarily earning greater rewards.

The Foolish bottom line
It's darn near impossible to successfully time the market with any degree of accuracy for any length of time. Where buy-and-hold investors can point to the likes of Warren Buffett, Peter Lynch, Walter and Edwin Schloss, Shelby Davis, and other examples of investors for whom invest-and-sit-tight has worked, the market timer will be hard-pressed to come up with one, let alone a half dozen or more, achieving similar results.

Whether it's maneuvering your shopping cart to the express lane or building your portfolio for a secure financial future, needless lane changing will only slow you down. Being in the game when your stocks make their move will get you to the front of the line faster.

Motley Fool Stock Advisor looks to hold a stock for a minimum of three to five years, but with an eye on holding for decades. That buy-and-hold philosophy has a lead to market-beating results that the timers can't match. A 30-day guest pass lets you see why.

Fool contributor Rich Duprey does not own any of the stocks mentioned in this article. You can see his holdings here. Coca-Cola is a Motley Fool Inside Value recommendation. J&J and JPMorgan are Income Investor picks. The Motley Fool has a disclosure policy.


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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 04, 2008, at 6:40 AM, Way2Risky wrote:

    >>if you had missed the best 10 days in that 15-year period, your returns would have dwindled to $31,994; if you had missed the best 30 days, you'd be looking at a mere $15,730.<<

    This remark is either banal or misleading or both. Why don't they talk about what would happen if you missed only missed the worst days? The same studies tell you exactly what would happen! Of course nobody can pick only the best days and only the worst days, so why not talk about what would happen if you missed BOTH the best and the worst?

    See this article for alternative view point:

    http://www.fundadvice.com/fehtml/mtstrategies/9410.html

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