If only we could time our investments perfectly ...
Of course, I'm skeptical about anyone being able to do so consistently. I have opposition, though. Just the other day at a restaurant, I overheard one middle-aged man asking a friend what he thinks of the market. The response was a discourse on why it was headed up right now.
Similarly, turn on your television and you'll find no shortage of financial prognosticators prognosticating about the market's future.
Such conversations seem pointless to me because I know that over the long run, the market moves up. That's what history proves, at least. In the short run, though, it's anybody's guess. The market swoons from time to time, and it can take years for it to regain lost ground.
But don't just take my word for it. Here's some academic research that reveals the dangers of attempted market timing.
The Towneley study
A frequently cited market-timing study was conducted by University of Michigan finance professor H. Nejat Seyhun for Towneley Capital Management. He found that if you invested in the stock market from 1963 through 1993, you would have earned an average annual return of 11.83%. That's pretty good.
But here's the amazing part. The period of 1963 through 1993 includes 7,802 trading days. If you were out of the market (not invested in it) for the 10 days when the market rose the most, your average annual return would only be 10.17%. If you sat out the 40 best days, your return would plunge to 7.09%. Up that to the 90 best days, and you're down to a mere 3.28%.
Most of the market's gains seem to occur on just a few days. This means anyone who tries to time the market is at risk of missing out. While some will suggest that there are dangerous times to be in the market, it's more dangerous to your portfolio to be out of it.
In 1995, the market (as measured by the S&P 500) advanced a whopping 34%. Some prognosticators suggested then that 1996 would give back some of that gain. Had you sat out 1996, you'd have missed out on a rise of just under 20%. In 1997, the S&P advanced 32%. Considering that the market's historical average return is 11%, those were heady years. Many predicted that we were surely due for a crash. Yet 1998 offered a jump of 26%. You just never know in the short term when the returns will be good or bad. (Of course, a major slump did eventually transpire.)
Beyond the market
Of course, it's useful to think beyond the market, because many of us invest in individual stocks and funds that don't generally move in lockstep with the market. Consider this: The S&P 500 declined by 10%, 11% and 24%, respectively, in 2000, 2001, and 2002. But that doesn't mean you couldn't have found some great investments during those years.
The Oakmark Select (FUND: OAKLX ) mutual fund, for example, rose some 26% in both 2000 and 2001 (and lost just 13% in 2002). It substantially beat the market in each of these years by investing in a concentrated portfolio of value-priced, U.S.-based mid- and large-cap companies. Indeed, the fund's current top holdings include Washington Mutual (NYSE: WM ) , Yum! Brands (NYSE: YUM ) , McDonald's (NYSE: MCD ) , Time Warner (NYSE: TWX ) , Intel (Nasdaq: INTC ) , and Dell (Nasdaq: DELL ) .
So you can see why it can be a good time to invest even when prognosticators are making short-term bearish calls. Because if you diversify among stocks and/or funds, you're likely to see some positive returns even during market downturns.
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Longtime Fool contributor Selena Maranjian owns shares of Oakmark Select, McDonald's, Yum! Brands, and Time Warner. Time Warner and Dell are Motley Fool Stock Advisor recommendations. Intel and Dell are Inside Value recommendations. The Motley Fool is Fools writing for Fools.