Ferri: The Problem With Market Timing

Ferri: The Problem With Market Timing

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

Reviewed by: Richard Ferri
Edited by: Richard Ferri

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.


Unintentional market timing wrongs can cut so deep that they may extend to the next generation. Children hear their parents complain about the stock market being rigged and how they will never invest in corporate America again. Remember Occupy Wall Street? This could be why many investors in their 20s are avoiding stocks altogether.

A few years ago, I compiled data on the percentage of household assets in equities from 1900 through 1999. The percentage of household assets held in stock or stock funds dropped after every severe bear market after adjusting for market losses. This amount did not creep back up to its pre-bear market level for almost a generation. A brief analysis of this data is available in my first book, Serious Money (see pages 45-47 of this free online version).

The avoidance phenomenon has repeated itself so far this century. Investors have been overall net sellers of equity mutual funds since 2008, despite the market trading at all-time highs. 2013 was the first year when global investors were net buyers of equity, buoyed by double-digit gains in stock prices.  Figure 1 illustrated net new cash flow to equity funds is related to world equity returns as reported by the 2014 Investment Company Fact Book.

Figure 1


Source: 2014 Investment Company Fact BookA Review of Trends and Activities in the U.S. Investment Company Industry, 54th Edition

One year does not make a trend, however. A recent State Street report suggests that investors may be heading back to cash.  Stashing Cash Under a Mattress reports that individual investors across the globe are allocating a high amount of their portfolios to cash this year. The report cites distrust of the market as the reason: “The crisis of 2008 is burned into their memories. The younger generations in particular are wary of investing in what they perceive to be ‘risky’ assets. Many of these investors experienced back-to-back crises and they simply don’t trust the markets.”

Market timing is difficult at best. Professional money managers pursue it to sell their investment strategy. That will not change. Individual investors are different. Many become entrapped by their own emotional reaction to market losses. There is a cure for this – it’s called education. People who have the right asset allocation from the start tend to be far less likely to capitulate in a bear market.


Richard Ferri, CFA, is founder and managing partner of Portfolio Solutions. He directs the firm's research and education, and is head of the Investment Committee. Ferri writes regularly for the Wall Street Journal, Forbes, the Journal of Financial Planning and his own blog at www.RickFerri.com.