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Strategic and tactical asset allocation

Demystifying market timing

August 2018

Trying to time investments to take advantage of the market's ups and downs is fiendishly difficult. It's an approach that's best avoided if you don't have the right tools. 

In theory, it’s an appealing strategy. By anticipating the financial market’s next move, whether that’s selling investments ahead of a sharp decline or buying them just before a strong rally, investors have the possibility of reaping significant rewards.

It’s just a shame that such a tactical approach – known as market timing –doesn’t work out quite so well in practice for the majority of investors. It is one thing to actively manage a portfolio strategically but quite another to take on risks based on one’s own intuition of where the market is heading in the very near term.

In its most extreme form, market timing has similarities to blackjack - the skill lies in knowing exactly when to stick or twist in order to beat the house. If you’re not an exceptionally skilled player, the probability of bettering the dealer as the game progresses is negligible to say the least.

Indeed, studies have shown that trying to time the market can be bad for your financial health over the long run.

severe market declines are rare

Number of times in past 15 years when global stocks have suffered a monthly fall of...

volatility number of months
Source: Pictet Asset Management. Data taken from returns of MSCI World Index covering period 31.12.2002-31.12.2017. Figures quoted in USD. 

In fact, research shows that one of the biggest risks of market timing is the cost of remaining un-invested, even for short periods.

For instance, as a recent US study demonstrated1, if investors had put USD100,000 into a fund of US stocks over the period 1996 to 2016 and left their portfolio alone, their investment would have grown to USD440,000. If, instead, they had opted to try to time the market and, say, had missed out on just 10 of the US stock market’s best trading days over that period, their investment would have grown to just USD219,000.

That’s a significant shortfall.

All this is not to say market timing is devoid of merit. It can work well for skilled, experienced investors - those who have invested through several market cycles and are able to collate and analyse huge volumes of data and identify market-moving trends before they gain momentum.

More generally, though, a better approach is to cleave to what history shows us: which is that, to have a greater chance of investment success, it is better to build and maintain a diversified portfolio of investments.

As the legendary investor Peter Lynch once observed: “far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.”