Market timing
Market timing refers to act(s) of investing based on the condition of the market as opposed to personal characteristics.[notes 1] For example, adjusting one's asset allocation toward greater fixed income holdings because the bond market has lost value recently and there is an expectation of a bond market recovery would be an act of market timing. On the other hand, adjusting one's asset allocation toward greater fixed income holdings because it is in one's asset allocation plan to do so (e.g., as one ages), is not an example of market timing.
Market timing is typically applied to stocks:[1]
- "It has always been an investor's dream to be able to time the market and earn excess returns. The technique of market timing is simple: Remain invested in the stock market when expected returns are high and switch to cash investments when the market is expected to underperform. The timing of the switch is indicated by signals based on sentiment or fundamental indicators."
The problem is finding a market timing rule that can work in the future, as opposed to the past. In William Sharpe's words, "the top or bottom of a cycle is only obvious after the fact (and sometimes long after the fact)".[2] The same author has calculated that to simply match the returns of a buy-and-hold strategy, a market timer must be right 70% to 80% of the time.
One way to evaluate whether market timing and performance chasing work better or worse than a buy and hold strategy is to compare the average return of mutual funds with the money-weighted return of investors in the same funds. In other words, are investors improving their returns by chasing hot funds, moving to cash and back to stocks, etc.? Morningstar has calculated the following average US data over five 10 year periods ending in 2014, 2015, 2016, 2017, and 2018:[3]
Fund category Fund return Investor return Gap Equity 6.8% 6.3% 0.6% Fixed income 4.0% 3.4% 0.6% Asset allocation 5.3% 5.5% -0.2% Alternative -0.6% -2.1% 1.4%
The table shows that on average, over 10 year periods, US investors in equity and fixed income funds earned 0.6% less than the funds there were invested in. It seems that asset allocation funds (including balanced funds, target date funds, etc.) are helping US investors behave better, on average. All funds considered, the results were similar in Europe, with a 0.5% average gap between fund returns and investor returns.
Notes
- ^ investopedia says:
- The act of attempting to predict the future direction of the market, typically through the use of technical indicators or economic data.
- The practice of switching among mutual fund asset classes in an attempt to profit from the changes in their market outlook. Some investors, especially academics, believe it is impossible to time the market. Other investors, notably active traders, believe strongly in market timing. Thus, whether market timing is possible is really a matter of opinion. What we can say with certainty is that it's very difficult to be successful at market timing continuously over the long-run. For the average investor who doesn't have the time (or desire) to watch the market on a daily basis, there are good reasons to avoid market timing and focus on investing for the long-run.
See also
- Market timing, Bogleheads wiki
References
- ^ Neuhierl A, Schlusche B (2011) Data snooping and market-timing rule performance, Journal of Financial Econometrics 9:550–587, available at SSRN, viewed June 16, 2020.
- ^ Sharpe W (1975) Likely gains from market timing. Financial Analysts Journal 31:60-69, viewed June 16, 2020.
- ^ Kinnel R et al. (2019) Mind the Gap 2019 -- A Report on Investor Returns Around the Globe. Morningstar, viewed June 12, 2020.