The Folly Of Market Timing

February 19, 2019

[Note: If you’re interested in this topic, please join me for a webinar next Wednesday, Feb. 27, at 3 p.m. ET. I’ll be joined by the fine folks from QS Investors.]

 

Each week I host an online chat here at ETF.com where I take pretty much any question from investors. I get simple questions (“What’s an ETF?”) and complicated questions (“How often do custodians need to be audited?”).

Because the sessions are moderated (by me), I can skip questions I don’t have a great answer for, and there’s one consistent sort of question I tend to leave on the cutting room floor: “Is now a good time to buy XYZ?”

I’ve been asked this question about gold, bitcoin, real estate and bonds. But often, it’s a simple question about timing the equity market. And if you happened to read my remembrance of Jack Bogle a few weeks ago (where I referred to my own investment philosophy as boring and forgetful), it should come as no surprise I’m not a big fan of market timing.

Danger Of Dollar-Cost Averaging

There are a lot of ways to think about the market-timing problem. Ritholtz Wealth Management analyst Nick Maggiulli penned a recent article looking at it from the perspective of a windfall investor.

In that framing, you have to decide between taking a mythical $1 million and getting it into the market now, versus slowly dribbling it into the market. The theory is that, by dollar-cost averaging over time, you’ll make some buys on days the market is down, and thus smooth out, or perhaps improve, your experience over time.

In that lens, Maggiulli concludes dollar-cost averaging is generally a bad idea:

 

 

But that only answers one version of this question: the choice between the lump sum into the 60/40 portfolio, or spreading out the lump sum. Importantly, this doesn’t suggest something like regular investing through a 401(k) plan is a bad idea. It simply says, “If you have the money, don’t wait to get it to work.”

Perfect Timing

The more insidious version of this is the question I regularly field: “is now … ?” It assumes the investor has a superpower: the ability to guess whether any given day is going to be the “right” day to jump in or to get out.

I’ve seen this sort of exercise in textbooks, but was curious what the real world looked like, so I ran the numbers.

For example, here’s what your returns look like in the S&P 500 since the March 2009 bottom, sliced four different ways: the market, the market minus the best 10 days, minus the worst 10 days, and minus all 20 outlier days:

 

 

While the market grew your $100 to $505, if you were a perfect market timer, you could have had $791 by skipping those 10 no-good-very-bad days. And if you were the worst market timer, and missed the very best 10 days, well, you would have only grown to $315. Skipping both sets got you pretty close to the overall market, at $493.

And then just for the last year:

 

 

Here, the market let you grow to $103.65, with a similar win/loss for your big bets.

You Need To Do Something Different

So what do you do with this information (other than ignore, with prejudice, the endless CNBC lower-thirds asking, “Is It Safe To Buy Stocks?”) Well, to my mind, it means if you’re concerned about playing defense with your equity positions, you need to do something different.

One thing you can do, of course, is just make sure you’re diversified: Don’t own one ETF with 50 stocks in it as your entire U.S. equity exposure; own international stocks, and bonds and alternative assets as well.

The other thing you can do is to look to products that either buffer your potential losses or seek to do this timing for you. Those require another leap of faith, however, either into the derivatives market (which for some investors is a bridge too far) or into someone else’s timing methodology.

Last, you can simply try and own those stocks that will be least likely to experience big swings. Look at that chart for the last year again. While the broad market was up 3.65%, if you remove the big-swing days—both up and down—you actually got a return of almost 6%.

That’s the theory behind minimizing volatility, and it’s been behind some of the early players in the space, like the Invesco S&P 500 Low Volatility ETF (SPLV).

 

 

The so called low-vol anomaly, which drove asset flows in 2012-2013, has had its good moments and bad, but it—and its competitors—all seek to smooth out the ride, hopefully avoiding the pain of the downside while getting most of the upside.

From the above, it’s clear that these kinds of approaches generally deliver on the promise, but they can require a lot of patience. If you bought into one of these strategies in, say, early 2017, you had to ride out a pretty painful period of 2018, where you underperformed. Of course, you would’ve been well-rewarded more recently:

 

 

Next-Step Approaches?

Thinking about the low-vol anomaly—and more broadly—about playing defense in the equity markets, has come a long way in the past decade, and I don’t think there’s a one-size-fits-all solution.

That said, there are novel approaches coming to market. Whether it’s dividend investing, chasing stock buybacks, screening for volatility, using derivatives or looking at “black box” timing engines, this is an area rife with both academic research and product development.

But whatever you do, please don’t ask me whether “today’s the day for XYZ.”

Note: If you’re interested in this topic, please join me for a webinar next Wednesday, Feb.27, at 3 p.m. ET. I’ll be joined by the fine folks from QS Investors, who have some thoughts on the matter and, of course, some solutions to offer. I’ll be poking under the hood, and hope you’ll come too.

Dave Nadig can be reached at [email protected]

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