Why Timing Market Swings Is a Bad Idea

Last Updated Dec 29, 2009 10:12 AM EST

The historical evidence demonstrates that, in aggregate, mutual fund investors:
  • Increase inflows after observing periods of strong performance, buying at high prices when future expected returns are lower
  • Sell after observing periods of poor performance, when future expected returns are now higher
Perhaps this behavior is what led Warren Buffett to conclude: "The most important quality for an investor is temperament, not intellect."

On March 10, the S&P 500 Index began its greatest rally since the Great Depression. However, investors were once again demonstrating that financial writer Jonathan Clements was right when he stated: "If you want to see the greatest threat to your financial future, go home and take a look in the mirror."

Morningstar's director of research Russ Kinnel provides us with some examples of how investor behavior destroys returns. Kinnel showed that "even when the official returns look pretty good, investors' performance can be lousy." For example:

  • The JPMorgan Intrepid Multi Cap Select fund returned 28.2 percent in the 12 months ended November. Unfortunately, the typical investor earned just 8.1 percent.
  • The Fidelity Mega Cap Stock fund returned 28.7 percent for the year through November. Unfortunately, the typical investor earned just 16.8 percent.
The road to investment hell is paved with market-timing efforts because so much of the long-term returns provided by the market come in short and unpredictable bursts. For example, one study, covering 107 years ending in 2006, found that the best 100 days (out of more than 29,000) accounted for virtually all (99.7 percent) of returns. Another study, covering the period 1926-1993, found that just 7 percent of months accounted for virtually all of the returns. (The other months provided an average return of just 0.01 percent.)

The 2009 rally provided another example of the need for discipline and patient persistence. After closing at 677 on March 9, the S&P 500 had risen 27 percent to 857 by April 9. Just one month later on May 8, the S&P 500 had risen to 929, a two-month gain of 37 percent, or about 60 percent of the total rally. And despite the huge rally, investors were pulling money out of equity funds in 2009.

The evidence is clear that market timing is a loser's game. Investors are best served by having a well-developed plan (including a rebalancing table), adhering to it and ignoring the noise of the market and the resulting emotions.

And when it comes to market forecasts and gurus, investors would be well served to remember J. Scott Armstrong's Seer-Sucker Theory on Expert Forecasts: "No matter how much evidence exists that seers do not exist, suckers will pay for the existence of seers."

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    Larry Swedroe is director of research for The BAM Alliance. He has authored or co-authored 13 books, including his most recent, Think, Act, and Invest Like Warren Buffett. His opinions and comments expressed on this site are his own and may not accurately reflect those of the firm.