Nobody likes to see losses in their investment portfolios. It's the dream of avoiding those losses that leads so many investors to try to time the market.
Like many of my colleagues at The Motley Fool, I'm a big proponent of long-term investing. Early on in my investing career, I learned the hard way that trying to time the market can often leave you locking in losses and missing out on big gains.
Yet some of the ways that people argue against market timing are truly cringe-worthy. Arguing the right point for the wrong reason is counterproductive and makes those with opposing views only more steadfast in their beliefs. Below, I'll look at one of the least effective arguments against market timing --and then turn to a better one that uses actual data to show what investors are really doing with their money.
Market timing is definitely bad -- if you're a terrible market timer
One key view of long-term investing is that because the stock market goes up over time, not being invested in stocks is on average a losing proposition. The more time you're fully invested, the greater the odds that you'll participate fully in the market's long-term gains. That's valid as a broad idea.
Market timers see downturns as a ticking time bomb -- but sometimes they end up holding the bag. Image source: Getty Images.
Yet in trying to make this point, many proponents of buy-and-hold investing come up with a ridiculous question: What would happen if you miss the market's best performing days?
The answer, obviously, is that missing top-performing days is bad. Fidelity recently looked at the market from 1980 to 2018 and determined that missing the five best days would cost you 35% of what a buy-and-hold investor would have. Missing the top 10 days would leave you with less than half of what a long-term investor's final balance, and missing the 50 best days would leave you with less than a 1/10th of that final balance.
The problem is that it ignores the other side of the coin. Missing the market's worst days would obviously prevent you from suffering huge losses. Over that same time period, if you'd managed to miss the five worst days, your portfolio would be more than 80% larger. Miss the 10 worst days, and you'd get a 160% bump. And you'd have more than 17 times more money at the end of those 38 years if you'd missed the 50 worst-performing market days over that span.
Clearly, it's not realistic to believe that any market timing could perfectly predict those bad days in advance to reap those big rewards. But it's not much less realistic that thinking that market timing will automatically leave you missing out on the best days. In fact, because those good and bad days tend to follow each other closely, just about the only thing you have to do is make sure not to decide to be a market timer immediately after the bad day happens -- because more often than not, good days tend to follow soon thereafter.
These investors are doing the right thing
The better argument against market timing comes from actual data. The Vanguard Group manages hundreds of billions of dollars in a couple of popular index mutual funds: Vanguard Total Stock Market (VTSMX 1.37%) and Vanguard 500 Index Fund (VFINX 1.31%). They're also available to investors in ETF form, with the Vanguard Total Stock Market ETF (VTI +0.87%) and the Vanguard 500 Index ETF (VOO +0.91%). The index mutual funds in particular are favorites among long-term investors.
Mutual fund guru Morningstar looks at the inflows and outflows for mutual funds across the market, and they measure the actual returns that investors earn. Often, investor returns are lower than the reported returns for the funds, because market-timing fund shareholders tend to sell their shares after declines and then buy them back after they've recovered.
With these funds, however, the lack of market-timing activity shows up in even better investor returns. That's because many investors in these funds keep adding money through good times and bad -- and dollar-cost averaging gives them more shares when prices are cheap, boosting their long-term investor returns.
|
Return Period |
Total Stock Market Index |
500 Index |
|---|---|---|
|
Three years |
9.81% vs. 9.43% |
11.44% vs. 10.09% |
|
Five years |
8.87% vs. 9.03% |
9.84% vs. 9.72% |
|
10 years |
13.20% vs. 12.69% |
14.77% vs. 12.99% |
Data source: Morningstar. First return is investor return; second is overall fund return.
Be opportunistic
Trying to time the market to avoid losses historically hasn't worked out well for investors. It's too easy to fall prey to your emotions and dump your stocks at the exact worst time.
However, the smarter way some people like essentially to time the market is to keep cash on hand for when markets drop. That lets you buy some stocks at bargain prices. It can cost you a bit of return during bull markets, but the boost from investing on the cheap during bear markets can keep you disciplined.
Regardless of how you do it, the best way to succeed at investing is to keep adding money to the market over time. Rather than worrying about capturing good days and avoiding bad ones, focusing on high-quality companies to invest in will serve you well over the long run.
