When you're right in the middle of a bull market, timing the market can seem like a good move. Your investments are moving up and your account balances are increasing -- which is exciting!
But it's not that easy, and studies have shown that more often than not investors will underperform the stock market over the long term. This is due, in part, to fees and taxes, but also because of these three reasons.
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1. It's very time-consuming
Professional fund managers spend their workdays researching and studying the economy and companies. They do this with the hope of identifying great investment opportunities that will increase their share value. But they don't have a crystal ball and can't predict with 100% accuracy when they should buy or sell these investments. And these misses can have a major effect on their fund's return.
If you are someone who is working a full-time job and trading in your spare time, missing out on good trading days can happen even more often because you get lost in your other responsibilities. This could result in an even bigger disparity between your return and the market return.
How much? From Jan. 3, 2000, through Dec. 31, 2019, if you were fully invested in an S&P 500 fund, you would've earned an average annual rate of return of 6.06%. Missing the best 10 stock market days would've reduced that return to 2.44% on average every year. Missing the best 20 days would've put you at a slightly positive return of 0.08% on average each year, and missing the best 30 days would've put you at a negative return of -1.95% on average annually.
2. It requires a lot of skill
You can learn how the stock market works and start investing, but actively trading can get more complicated. There may be some professional money managers who have a lot of knowledge in different areas, but usually, money managers have employees who have specializations. Some specializations are so granular that a single division of employees handles just one market sector. Matching this skillset potentially means becoming an expert in many different areas and learning detailed information -- like how stocks with various market capitalizations, geographic regions, and styles perform in different market cycles.
Even then, having this knowledge doesn't mean that you'll beat the market. Most professional money managers don't consistently do better than an S&P 500 fund. According to a report published by SPIVA, 77.97% of large-cap U.S. funds have underperformed the S&P 500 index over a five-year period of time.
3. Your emotions can get in the way
Trading can get emotional. As much as you know that you should buy stocks when they are trading at low prices, doing this can be difficult. In 2008, bank stocks were hit the hardest, and investing in this industry may have been scary. A finance stock like Goldman Sachs (GS -0.23%) started the year trading at $214.80. By Nov. 20, 2008, it closed at a low of $52.
If you considered buying it at the time, seeing other banks fail may have made you hold off on purchasing it. But if you'd bought this stock at its low, you would've seen it rise to $82.06 by the end of the year -- and now it's trading near $240. If you owned it at the time and sold it out of fear, you would've realized your loss and wouldn't have recouped your money.
The better alternative to market timing
So what's your best bet? Don't time the market. Sure, you could be a natural and do well overall, but just a few misses cost you in the form of investment return and dollars accumulated toward your goal.
Instead, make your life easier and consider investing the main portion of your accounts in a simple ETF or index fund. If you find trading exciting and love doing it, you can set aside a portion of your accounts for trading. Just remember that even if you do well in the short term, properly gauging whether or not you're beating the market should pass the test of time.
