Why Market Timing Is a Joke

I get tired of this same old "buy and hold" advice. In every secular bear market, folks who "stayed the course" generally made very little or no money. Instead, if they'd followed trends and got out of the market when it was crashing and bought back in at some point near the bottom, they'd have increased their wealth substantially.

This heavily edited comment is similar to many we receive at the Fool. I see more of these any time the market's down, as it has been recently. Let me point out why this type of thinking is not only wrong but dangerous. Plus, I'll tell you about what is perhaps the most overlooked factor keeping you from achieving great long-term performance.

What is "buy and hold"?
First, let's define some terms so we're all talking about the same thing. Most of us at the Fool advocate buying a stock with the intention of holding for the long term. We do not advocate buying, forgetting, and never monitoring your investment (though there is some illustrative power in that; see below). We may decide to sell for any number of reasons, including valuation or a change in the original investing thesis -- all of which are different from market timing.

I define market timing the same as my commenter above: The ability to call tops and bottoms and sell and buy all of our stocks accordingly. I do not mean to imply that we can't reasonably say when the market as a whole seems undervalued or richly valued -- but as we know, the market can continue to go down (or up!) a lot longer than common sense would dictate.

With that out of the way, here's why "buy to hold" investing works, and market timing doesn't.

Trade more, be poor
Studies have shown a direct correlation between the amount of trading and portfolio performance, and not in a good way. Brad Barber and Terrance Odean have published at least two studies on this subject, concluding that "trading is hazardous to your wealth."

Studies are one thing, but direct observational experience is another. Everyone can name several great buy-and-hold investors, such as Warren Buffett, Peter Lynch, Ben Graham, and Philip Fisher. None of these folks made their fortune by predicting market tops and bottoms; rather, they found great companies at fair prices and held most of them for a long time.

Our own David and Tom Gardner are another example of verifiable, on-the-record success. This coming March will mark the 10th anniversary of Motley Fool Stock Advisor, and the brothers have averaged 90+% returns for their monthly stock recommendations. Equal amounts placed in the S&P 500 over that time would have averaged 10.8%.

Now, let me ask you, who are history's great market timers?

Coming up with just a few names wouldn't be enough to stack against the list of buy-and-hold investors, but at least we could consider the possibility that market timing was viable for some people. Problem is, I'll bet you can't come up with one. Single. Name.

Sure, there have been people who've made great timing calls; with dozens of bull and bear "experts" constantly cacophonying on CNBC and the like, there are folks who are bound to get some calls right. But they can't do it consistently.

Even a simpleton
Again, while I don't advocate buy-and-forget investing, I wanted to bring up a great example of the power of buying and holding great companies. In July of 1995, Tom Gardner was inspired by a TV ad from a big financial firm, preaching that the individual investor just didn't have what it took to manage his own money. Tom wrote: "I decided to string together a portfolio of 10 stocks online that I believed could be held as a group for 10 years and expected to generate excellent returns."

Here are those 10 stocks, which he dubbed the Simpleton Portfolio, along with returns to-date:

Simpleton Port

Returns Since 7/7/1995

Dell (UNKNOWN: DELL.DL  )

1,332%

America Online

575%1

Sun Microsystems

76%2

Cisco (NASDAQ: CSCO  )

436%

Texas Instruments (NASDAQ: TXN  )

255%

Intel (NASDAQ: INTC  )

196%

Gap (NYSE: GPS  )

275%

Microsoft (NASDAQ: MSFT  )

454%

Hewlett-Packard (NYSE: HPQ  )

74%

Silicon Graphics

(100%)3

Average

357%

S&P 500

173%

Returns provided by Yahoo! Finance and author's calculations.
1-Estimated returns including Time Warner merger and spinoff.
2-Estimated returns including acquisition by Oracle.
3-Silicon Graphics (then SGI) filed for bankruptcy in 2009.

First, let me come right out and say that all of these companies are still well off their all-time highs, achieved at the height of the tech bubble that popped in 2000. Still, a lot about what you need to know about investing is encapsulated in this one remarkable table. Tom began this Simpleton Portfolio with about five years to go in a great bull market, which was followed by the great aforementioned crash of 2000. Since then, of course, we had a modest rise in the market, followed by yet another crash, the Great Recession, fear and loathing in Europe, Lady Gaga, and the debt-ceiling debacle.

This portfolio reflects bankruptcies, mergers, spinoffs, and several market cycles. It also reflects the awesome power of finding and investing in a portfolio of dominant and innovative companies. Some won't work out, of course, and some will spectacularly.

One secret ingredient
And now the most important part of this article, that most-overlooked factor in achieving great returns I mentioned earlier. It is this: The simple step of adding new money to the market on a regular basis. If you aren't doing this, you're cutting yourself off at the knees.

For example, from the date Stock Advisor launched until now, the S&P 500 is almost exactly where it was nine-and-a-half years ago. And yet, as I mentioned above, those who invested monthly -- through the ups and downs of a very tumultuous period -- would have an average return of 10.8% for each of those monthly positions!

Another example is the oft-quoted tidbit that it took 25 years for investors to break even during the Great Depression. On Sept. 3, 1929, the Dow Jones Industrial Average hit 381 -- and it did not reach that level again until November 1954. But as Jeremy Siegel pointed out in his book The Future for Investors, those who did little more than reinvest their dividends during that period actually showed an annual rate of return of more than 6% during that 25-year stretch!

Start now
If you're able to add new money to the market regularly, you'll be buying more shares when stocks are low, and fewer shares when prices are high. You can keep a long-term perspective, and not worry about trying to time the market, and more than likely being left behind when major rallies occur.

The evidence shows -- history shows -- that this is the best (sane) way for us individual investors to generate the kinds of returns we need to achieve financial independence.

If you're looking for some candidates, be sure to check out our free report "5 Stocks The Motley Fool Owns -- And You Should Too." These five companies were hand-selected by top Motley Fool equity analysts, and the Fool put real money behind their picks. Click here to get the report.


Read/Post Comments (38) | Recommend This Article (46)

Comments from our Foolish Readers

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 September 15, 2011, at 3:19 PM, theHedgehog wrote:

    If someone were actually able to time the market successfully, either all the time or even just most of the time, we'd see them month after month, year after year on CNBC. It doesn't happen. Instead, what we see is a parade of people selling their "produits du jour"; each of which has a limited shelf life that is usually not mentioned.

  • Report this Comment On September 15, 2011, at 4:37 PM, edmond5 wrote:

    Well, I have a question. I was under the impression The Motley Fool were big disciples of IBD and William O'neal. I believe it's even mentioned in The Motley Fool Investment Guide. O'neal says in his classic book How to Make Money in Stocks p. 200 :

    "Don't let anyone tell you that you can't time the market. This is a giant myth passed on mainly by Wall Street, the media, and those who have never been able to do it, so they think it's impossible."

    Not trying to be sarcastic...just getting a lot of mixed signals as what is considered 'buy and hold' and what is 'market timing.' Anyway, good article.

  • Report this Comment On September 15, 2011, at 4:47 PM, peterod wrote:

    just check out some of your top fools track record....cecamadocy, bravo bevo, etc. are living statistical proof..... that doesn't mean those trades can be scaleable and done with large sums of money like buffett....

  • Report this Comment On September 15, 2011, at 5:15 PM, daustin97222 wrote:

    It is an interesting debate.On the one hand, you have decades of data showing that so many traders fail and/or go broke. On the other hand, you have national talk show hosts claiming that they called the "top" and the "bottom" in the last supercycle, and that they have the track record to prove it. Out of foolish respect I won't name them but you can figure out who we're talking about here. So who is right? It would be interesting for the objective observer and statistician to weigh in (Mark Hulbert, perhaps?).

    Speaking for myself: I am a lousy trader.

  • Report this Comment On September 15, 2011, at 5:25 PM, rodnog wrote:

    A year ago, when i first became interested in the stockmarket, i read a lot about technical analysis. Now, the whole TA thing, for timing the market, seems to be just like homeopathy or spirit healing: if it works, it's because it works; if it doesn't work, you didn't do it right.

    Thank you Fool, for educating me to this point.

  • Report this Comment On September 15, 2011, at 5:28 PM, hbofbyu wrote:

    Imagine 1000 people throwing darts at a dart-board. You will find a good chunk of them are genius dart throwers (even though it's chance). Same goes for those who get over-sized returns in stocks (luck).

  • Report this Comment On September 15, 2011, at 5:35 PM, stan8331 wrote:

    Good article - the point about buying more shares along the way is critical. Anyone who buys in at the top of a bubble and then refuses to ever buy any more DESERVES to lose money.

    I think it is possible to make decent money as a trader, but it requires a great deal of effort to achieve relatively modest returns. You're competing against investment bank supercomputers.

    I'll stick with buying well-managed companies, adding to those positions over time and buying even more when prices get really cheap. Even if I believed it could deliver equivalent returns, I'm just not energetic enough for the whiz-bang trading approach.

  • Report this Comment On September 15, 2011, at 6:34 PM, TMFOrangeblood wrote:

    @edmond 5: We definitely do not follow O'Neil's philosophy. Back when the Investment Guide was written, we suggested getting data from IBD, and we used their relative strength rating in the Foolish 8 screen. This was back in the day when newspapers were relevant for getting data. :)

  • Report this Comment On September 15, 2011, at 8:12 PM, BuyloPESellHiPE wrote:

    Point well made Rex -- Every so often, I find myself doubting if buying good companies at reasonable prices and holding them is the right approach. Articles like this and my own personal experiences with the market (thank god I have kept a complete history of my buys and sells) have proven to me over and over again, that the market can ONLY tell you when to Buy. It can NEVER dictate when to Sell. I usually sell when I find a good deal on a better issue that what I have. Other than that, I simply hold. Most of my stocks are dividend earners and I find that it is a good place to park my investment ie: in dividend earning issues than in a bond fund or some other such useless investment. Thanks again for the reminder!

  • Report this Comment On September 15, 2011, at 8:46 PM, vidar712 wrote:

    Those investors who sell shares at the market peak and buy again at market low are not getting enough return for their ability to time the market.

    What they should do is buy Calls (with an expiration right after the market peak, and with a strike price that is *just* in the money (at peak)). Then, during the peak, sell those calls and buy Puts (with an expiration right after the market trough, and at a strike price just in the money (at the bottom).)

    That would maximize returns with the smallest amount of effort.

  • Report this Comment On September 15, 2011, at 9:05 PM, lmkwin1 wrote:

    buying and holding and buying more of a dog is not an admirable trait. Buying small growing companies, in a favorable market environment is the only thing that will make you a "successful" investor or trader. Owning above trend and not owning them below trendlines is really very simple. Using point and figure will provide you very clear signals. Bullish percent indicators will provide very clear signals. Most Motley fool portfolio returns are greatly skewed by some spectacular winners and horrible losers. The spectacular winners share the technical traits you will need to succeed. Fundamentals make you feel good but technicals alone is the only way you will make money.

  • Report this Comment On September 15, 2011, at 9:43 PM, penchy1 wrote:

    Rex, quite poignant examples of LTBH. Something for my adult children to grasp. Great article.

    Mark

  • Report this Comment On September 15, 2011, at 10:27 PM, RallyCry wrote:

    I have to disagree Rex. If you can follow some basic strategies, you can limit your downside during volatile periods.

    http://caps.fool.com/Blogs/market-timing-is-not-a-joke/64261...

  • Report this Comment On September 15, 2011, at 10:40 PM, TMFDukenewkirk wrote:

    Good article, thanks. However, I'm a big fan of market timers, chart readers astrologists and fortune tellers alike. Their never ending efforts to win the big prize every time, right out of the gate are to be applauded. Their fearless defiance of logic in the face of endless statistics in true contrarian fashion require a bravery and resolve that is unfathomable to most mere mortals.

    I believe the most salient point made in the whole article, in fact, the only point I feel you'd need to consider to come up with the 'only' common sense conclusion, is the challenge to name, JUST ONE famous 'trader'. Just one. Even if someone could name a successful one they are aware of, clearly they would be a rarity and not an indication of what the average person could achieve.

    Were this a simple challenge, there would be a counterpart to stack up against the likes of Buffet, Lynch, Graham that would roll off everyone's tongues as easily as those names. Sadly, something almost as uncommon as famous traders is sense. Of course those with sense should never lament this point as the sense that is lacking helps greatly to provide the inefficient market LTBH investors relish. Therefore, I applaud all and any efforts made to time the market and outsmart good sense.

    For any LTBH advocate out there, we can find, on the internet, on TV, on the radio, hundreds of talking heads talking up active trading or market timing. This is the idea being flogged relentlessly to the public. Also being flogged are thousands of get rich quick schemes, tools or programs of infinite variety. We should therefore assume there must be far more disgustingly rich people than average or poor folks in this world. Why, there's simply so very many ways for all of us to get rich.

    Smart, patient, long term, common sense investing is not the same money maker for those selling get rich quick fantasies.

    Worse of all, any fool with an opinion or idea these days can easily have their day in the sun by merely posting whatever dribble they wish online or in countless publications just looking for content, and the more fantastic, outlandish, or tragic for that matter the post, likely the more attention it will garner. For the love of Pete, consider that the National Review published Donald Luskin and that there's always an audience for the fantastic..

    http://www.j-bradford-delong.net/movable_type/2005-3_archive...

    Leave logic to Warren Buffet, Peter Lynch, Benjamin Graham, countless other LTBH investors we've all heard of. Momentum traders and market timers have no use for their Foolish brand of voodoo. They will get rich now, while LTBH Fools wait endlessly for their returns.

  • Report this Comment On September 15, 2011, at 10:58 PM, MartianRtns wrote:

    fwiw, PL's turnover in the Magellan fund was over 300% in the first three years. I believe it averaged well over 100% in most years after. In Intelligent Investor, Ben Graham actively promoted a style of moving stock allocations up and down according to market valuations. Finally, there is a quote from Buffett in either the annuals or the earlier letters that he engaged in rapid turnover during his partnership days.

    None of this means buy to hold as a concept is invalid, but if you want to ascribe motives to the investment greats, you might want to understand exactly how those greats actually invested, and they did turn things over.

  • Report this Comment On September 15, 2011, at 11:48 PM, MazonCreekRich wrote:

    I agree that a long term perspective is advisable. But I think we do know a great market timer -- Jeremy Grantham. Actually, he is a "bubble" timer -- he sells when markets as a whole are greatly overvalued and buys when bubbles burst and markets as a whole are deeply undervalued. And his record is long and admirable.

    I guess my point is that -- like Grantham -- i think buubles and burst bubbles are much easier to identify than valuation anomalies in stocks, and should not be ignored by reason of a LTBH perspective.

    Sometimes the line between a value investor and a market timer is not all that clear.

  • Report this Comment On September 16, 2011, at 12:24 AM, MichaelDSimms wrote:

    As a smart man once said:

    I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years.

    Warren Buffett

  • Report this Comment On September 16, 2011, at 12:28 AM, MusiCali wrote:

    I can think of 1 person over the last 30 or more years that is a famous market timer

    Ken Heebner

  • Report this Comment On September 16, 2011, at 4:25 AM, tommcdee wrote:

    Can't name just one? It seems to me that market timing works for some famous traders, like George Soros, Carl Icahn, or John Paulson for example.

  • Report this Comment On September 16, 2011, at 5:02 AM, Professio wrote:

    Rex,

    I have to agree Humans are not particularly good at spotting market trends. We tend to spot patterns and trends in almost everything. I could make a few random charts and I bet some would spot similar patterns in those charts, as long as they want to see them. However, Renaissance Technologies has used Statistics and Math to consistently time the market right. It is purely based on statistical prediction, automated by intelligent computers obviously. Their funds have generated above average returns since 1982, I would say that's pretty damn impressive. Of course, many such computer picking automated systems also fail, but it can work and has been proven to work by Renaissance Technologies.

  • Report this Comment On September 16, 2011, at 6:15 AM, MattHylland wrote:

    John Paulson as a great market timer? Hows his 'great' fund doing this year?

    Everyone has their moment, everyone gets lucky, just not all the time.

  • Report this Comment On September 16, 2011, at 9:25 AM, tommcdee wrote:

    I understand Mr. Paulson's fund is down by more than 30% this year. That's definitely a lousy year. However, if you look at what he has done over the past 15 years, you cannot attribute the results to luck.

  • Report this Comment On September 16, 2011, at 11:47 AM, johannascott wrote:

    Johanna Scott of www.betterment.com here. Timing the market and overconfidence bias is something we think about a great deal at Betterment. There is so much data to support to Motley Fool's article - that you can't time the market. Humans tend to think we’re above average. In reality, 90% of people underperform the market by 5%. That's why services like ours exist - to help you make the right decisions as your "most rational thinking self".

    Enjoying the thrill of trading is separate and - to me - not worth risking your hard earned...

  • Report this Comment On September 16, 2011, at 1:06 PM, TMFOrangeblood wrote:

    Thank you MazonCreekRich, brian326, and tommcdee for at least trying to come up with some names. I don't consider identifying and investing in trends to be market timing as, for example, Paulson did with subprime mortgages. I don't think these guys would identify themselves as market timers (though I'm less familiar with Heebner, and don't know his track record). And good line about Grantham being a "bubble timer." :)

  • Report this Comment On September 16, 2011, at 9:02 PM, FleaBagger wrote:

    Can you define the difference between market timing and trend investing?

  • Report this Comment On September 16, 2011, at 10:50 PM, TMFOrangeblood wrote:

    @fleabagger: Buying stocks you think will benefit from a certain trend (increased need for healthcare, security, etc.) is just part of fundamental analysis. Buying or selling all your stocks because you think the market’s going up or down is how I defined market timing in this story.

  • Report this Comment On September 18, 2011, at 1:35 AM, IlluminatInvest wrote:

    I don't mean to make light of a tragic case, but the man generally considered to be the greatest technical market timing trader of all time (Jesse Livermore) committed suicide after going broke for a second time.

  • Report this Comment On September 21, 2011, at 4:35 PM, NajdorfSicilian wrote:

    There are, literally dozens of $billionaires who have made their money from 'market timing': Alan Howard, PTJ, Soros, Druckenmiller, Robertson, Steinhardt, Kovner, Shaw, Harding, et al.

    As others have noted, Lynch, Buffett and their ilk would sometimes have 300% turnover in a year.

    Just because *you* cannot do it, TMF, does not mean it cannot be done. With trading costs essentially zero [or less] these days, BnH makes less sense than it ever did.

    Also, LOL sample bias at your one selectively chose data point from 16 years ago. Really?

  • Report this Comment On September 21, 2011, at 4:36 PM, NajdorfSicilian wrote:

    @evan, it was his 7th time, not his 2nd. And not because he wasn't a good timer, but because he had probably the world's worst risk mgmt skills - a differing skill set entirely.

    And no one really thinks he was the 'best ever.' I'll take PTJ, although both Dalio and Howard are coming up fast.

  • Report this Comment On September 21, 2011, at 4:41 PM, NajdorfSicilian wrote:

    Also, I'm not sure touting a ~6.6% return, gross of inflation is anything to write home about.

    You could have bought investment-grade bonds at 8%+ and suffered less than 1/5th the volatility. Or prime ABS and made even more.

    Or you could have bought Yacktman, or Royce, or any number of well-known investors' funds [well-known at the time.]

  • Report this Comment On September 21, 2011, at 5:10 PM, rodnog wrote:

    RE: Buffet/Lynch 300% turnover in a year...

    That doesn't mean they're engaging in market timing. I'm sure those transactions were more likely to have been carried out based on fundamentals, than on "we have a MACD cross, and RSI is crossing up through 50, and it's touching the upper bolinger band"

  • Report this Comment On September 23, 2011, at 10:56 AM, JohnDimitri wrote:

    Those who can time the market, time the market. Those who cant tell us to buy and hold.

  • Report this Comment On September 23, 2011, at 12:24 PM, Richh100 wrote:

    I look at Market Timing, not as being an active trader, but someone who will buy after the market has made a major crash and will sell when it appears the market is too high and we are about ready for a recession. Right now is an example of this. The market appears to be ready for a sell off so I would not be fully invested. I will set some cash aside in case the market does crash. If it does, then I will have some money to invest.

    In the meantime, I am not going to trade in and out of the market looking for minor profits.

  • Report this Comment On September 23, 2011, at 3:47 PM, mickytwo wrote:

    I've found there are many ways to judge whether the Market is overvalued or undervalued. Think of Shillers Market PE at over 25 or under 15, or when more than 80% of stocks are over or under their 200day moving average. There are many other signs that I use to good effect. Hold your Stocks for the longer term and just cream off any of your overvalued stocks near the top and buy more undervalued stocks near the bottom later with the cash. No need to be exact about it, you'll get a satisfactory return over the longer term.

    Not sure its really Market timing but it seems to work.

  • Report this Comment On September 23, 2011, at 8:12 PM, dbtheonly wrote:

    evanmacdonald,

    Livermore was not a market timer, he was an inside information investor. His ability to "get there first" made him look like a genius. When insider trading was limited by the SEC (was it 34?) Livermore was out-of-business. I seem to remember a criminal action, but do not want to go too far on memory alone.

  • Report this Comment On September 23, 2011, at 9:02 PM, chartwhizzard wrote:

    For those naysayers of market timing and technical analysis you need to do more homework. Netflix is a primary example. The charts were a clear sell on the break of $248 . Based on the $304 high we shorted with a target of $120 - $130 .We have been short the markets from 12,700 . THAT sell signal has been on my home phone and answering machine for months. You don't have to be a trader to be a technician. Netflix still has issues but then again so does our entire economy. Anyone that thinks We can move forward without improving the job and debt situation is kidding themselves.

    Don

  • Report this Comment On September 25, 2011, at 11:40 AM, jnlynx wrote:

    Touting the simpleton portfolio is passe.Let's see how it has done since jan 1 2008 (giving it a fair chance) then from market peak to today.. I doubt seriously it WILL DO BETTER IN THE NEXT 5 YEARS HENCE THAN S&P 500.. ANY TAKERS

  • Report this Comment On January 18, 2014, at 4:24 PM, vardnell wrote:

    You've got a number of good points, but what about (for example) Pu Shen's work on the success of market timing http://www.kansascityfed.org/Publicat/Reswkpap/PDF/RWP02-01.... in certain circumstances. And it seems like there are a number of commercial applications that take advantage of opportunities to time markets (say, InvertAlert or fibtimer). Isn't the market test whether or not those companies stay in business? Wouldn't they have vanished long ago if they weren't helping their customers get an edge?

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