Do You Time The Market? Deconstructing Market Timing Strategies

The good and bad of market timing. Are you prepared to buy and hold forever?

Technically speaking, there’s no such thing as “buying and holding” forever because in order to be a responsible steward of your portfolio, you’d have to take it through times of evolution, growth, adjustment and reorientation, all depending on where you are with your life, goals and financial expectations. Here’s where I split hairs about the concept of market timing.

When I wrote that I subscribed to a newsletter for some financial information, I admitted that the newsletter practiced some form of “market timing”. It was the kind of market timing that didn’t occur frequently (e.g. not for day traders), and which was based on systematic indicators that track the state of the economy and the fundamentals of the overall market. It was a signal-based form of market timing practiced by some who keep their eye on the long-term trends and behavior of the market. Over 15 years ago, I thought I’d try out the service for $200 a year and today, here we are still awaiting each monthly report with curious anticipation, wondering what the author (a money guru in his own right) would say about recent market events.

So what I’d like to do in this post is to take a closer look at market timing. I am quite aware about the questionable record that market timers have racked up. For starters, check out these historical statistics that show how different investing strategies have stacked up over the long term (source: Charles Schwab On Investing magazine):

Given these numbers, the market timing strategy looks like a truly horrid plan to pursue. Market timing lagged all other forms of investing here by a significant margin. But who is the “Average Market Timer” being described here? And what does “market timing” really mean? Are we talking about the professional market speculator, the random casual day trader or the novice investor who decides one day to play with the stock market?

Market timing appears to have various flavors and not all timing approaches may lead to investment underperformance. I say this, while citing this piece about market timing, which attempts to describe different approaches that fall under the timing umbrella:

Different Market Timing Strategies

#1 Short-term market timing
Short term market timing refers to day trading or timing cycles that measure out in hours, weeks or months. Many times, people who engage in this are emotional investors. Some are true speculators who do it for a living with an elite group doing extremely well. But unfortunately for the average joe trader, after taxes, transaction fees and other such costs, the approach that involves jumping in and out of equities isn’t really all that rewarding. I have never tried this but lots of my own friends have, and I’ve seen how they’ve fared, making me want to avoid it like the plague.

#2 Long-term market timing
This method is employed by many market professionals — yes, including the newsletters I’ve been talking about — and involves determining long term market trends that cut across several years. Market indicators are monitored in order to identify existing trends and such analysts attempt to describe where the market may be headed. Once in a while, they call out a buy or sell signal that involves some shifts in their model portfolios. I’ve been intrigued by this strategy as it does have a basis on economic and market fundamentals.

#3 Buying and selling an entire portfolio (or a majority of it)
Both short or long term timing usually involves the manipulation of one’s entire portfolio, something I strongly doubt I’d ever attempt. Making dramatic moves that involve your entire portfolio can prove to be disastrous because of the level of concentration you are subjecting your funds to. Timing with a little piece of your portfolio in order to tweak it is fine. Partial timing to the smallest degree you can muster may be okay. But moving in and out of the market with your entire position is a huge gamble anyone is bound to lose. I’m not sure how the experts and professionals do it, but I truly doubt they ever take 100% of their holdings and make a single bet with it.

#4 Compulsive rebalancing and shifting of one’s asset allocation
There doesn’t seem to be any reason why anyone would tweak their portfolio more than a couple of times a year. I’d expect that a properly diversified portfolio wouldn’t result in significant imbalances throughout the year that would entail constant tweaking. By playing with your allocation too much, transaction costs, fees and taxes can eat into your holdings.

#5 Buying and selling stocks given price targets or high valuations
I’ve seen this strategy play out where people set targets to buy and sell. My own experience doing this has only resulted in mediocre returns. In the end, I find that this activity is “just a wash” and a waste of time since winning positions are not given the opportunity to ride further on strength and I find that the record keeping I have to do while dealing with frequent trades becomes a bear.

#6 Buying and selling positions as an emotional reaction
This is plain and simple the wrong way to invest. Any kind of trading that happens due to emotional reactions is the sure way to get burned. This occurs when someone buys a stock based on a tip heard at the office water cooler, or when someone sells his holdings after reading a scary headline in his local paper. If you find yourself too emotional about the stock market and you aren’t able to sleep at night, then you may want to cut back on your positions.

#7 Buying and selling as a strategic move tied to market behavior
If you’ve told yourself that you’d buy and sell based on a well-defined system that you’ve established prior to any market events occurring, then to some degree, you’re making moves strategically. That is, you’ve developed a plan and you’re performing transactions based on the plan. For instance, if you’ve decided you’d do some portfolio rebalancing in a way that your allocation benefits from changes that are further encouraged by the existing market climate, then you’re acting according to strategy. For instance, while the market hiccups, I tend to reallocate funds from cash to equities to take advantage of stocks’ weaker prices. The difference between acting on strategy and acting on emotion is found in planning, anticipation and preparation.

Are all these “bad strategies”? I’d argue not, but your success with them depends on many assumptions and factors. I will agree that market timing is absolutely destructive to the portfolio of inexperienced investors, especially if it is employed as one’s financial strategy of choice. The conventional wisdom is true: TIME IN the market is much more important than TIMING the market. As an average investor, long term investing and staying the course (overused as these terms have been) is the way to go. But as an investor who continually wants to learn, I keep an open mind about this subject and won’t paint all the timing strategies with a broad negative brush.

Now I’m not trying to make an excuse for ourselves and our infatuation with a market timing strategist and his newsletter. In fact, this newsletter aligns with our core investment philosophies which are centered on solid long-term investing. It complements us as proponents of asset allocation, automatic rebalancing, goal setting and risk tolerance assessment.

But I’m also a closet market timer (a contrarian at that!) if there’s such a thing: as someone who buys when things drop and who may sell off just a bit when prices seem lofty. If you’re 90% an asset-allocating-long-term-investing buy and holder, who’s using the other 10% of your assets to explore the vagaries of the market, then you’re a perfectly fine investor in my book: I find that a little experimentation in the markets is healthy.

If you can’t help but be a little scared or excited over what the market is doing, then I’d suggest timing therapy with a little bit of play money. A little bit of buying and selling and dabbling in the market within the confines of a tight financial plan shouldn’t be a bad thing.

 
Image Credit: Schwab Report, Wagner Blog

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