Ferri: The Problem With Market Timing

June 13, 2014

For market timers, the odds for success simply aren't there.

Successful market timing requires two correct decisions: when to get out and when to back get in. Guessing right once is a 50/50 proposition. Guessing right twice drops the odds to only 25 percent. One wrong guess and you shoot yourself in one foot; two wrong guesses and you shoot yourself in both feet. This is what makes market timing so difficult.

I divide market timing into two types: intentional timing and unintentional timing. Intentional timing is based on fundamental and technical factors to determine when asset classes are attractive and when they are not, and then bets are placed accordingly. Unintentional timing is behavioral – it’s rooted in a natural fear and greed mechanism that we must learn to control.

Many professional portfolio managers practice intentional market timing because it’s how they appear smart to their clients and potential clients–and justify their high fees. I’ve sat on many panels during industry conferences where portfolio managers gloat over how they predicted a market crash, or a jump in interest rates, or the fall in gold prices, etc.

What these gurus fail to mention (and what I point out) is that most of them were not able to repeat their good fortune. They failed to get their clients back into markets before the recovery and couldn’t repeat the process consistently.

Practically every portfolio manager who guessed right on the downside during the financial crisis and missed the upside has the same excuse, “We were being conservative.” I don’t buy it. Being right only half the time is not successful market timing. Being conservative is a poor excuse for being wrong.

Bad things can happen when an individual investor unintentionally times the market due to emotion. Being wrong once means getting out at the wrong time, or not getting back in at the right time. Being wrong on both can lead to long-lasting detrimental effects. Capitulation in a bear market and then sitting out during the recovery creates deep psychosocial damage. This damage can keep investors away from the markets for an extended period of time – sometimes for life.



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