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Why Timing the Stock Market Never Works

Written by Dan Solin on August 24, 2010 in Retirement  |   3 comments

Wouldn’t it be great if you knew when the markets were going to take off or tank? Armed with that knowledge, you’d have no trouble achieving your investment goals. You’d just buy if the markets were going up and sell if they were going down….

Timing stock market does not workWouldn’t it be great if you knew when the markets were going to take off or tank?

Armed with that knowledge, you’d have no trouble achieving your investment goals. You’d just buy if the markets were going up and sell if they were going down.

Here’s the problem with that scenario:

Market direction is driven by tomorrow’s news. No one knows tomorrow’s news. If we did, we would have predicted the oil spill in the Gulf of Mexico and the precipitous decline in the price of BP’s stock.

The impossibility of predicting the unknowable does not stop the financial media and self-styled investment gurus from looking into their crystal ball and providing investors with advice. Here’s one of many examples:

In its issue dated December 20, 2007, BusinessWeek ran an article entitled “What the Pros Are Saying.” One of the “pros” was Elaine Garzarelli, who achieved cult status by advising her clients to sell just before the 1987 crash.

Garzarelli noted that her “models” showed the S&P 500 was “undervalued by 25 percent.” She advised investors to buy some stocks that were “beaten down,” including Lehman Brothers, Bear Stearns, and Merrill Lynch, stating that her “indicators are extremely bullish.”

Fast-forward to the end of 2008:

  • The S&P 500 decreased by 38.5 percent.
  • Lehman Brothers filed for bankruptcy.
  • Bear Stearns and Merrill Lynch were merged into other companies in order to avoid total collapse.

If you listen to market timers and miss out on just a few days in the market, you could clobber your returns. For the period from 1997 to 2006, there were 2,516 trading days. If you missed the 20 days with the biggest gains, you wiped out your profits. If you stayed invested for all 2,516 days, you had an annualized return of 8.4 percent.

Gloom and doom inspires fear. Fear causes investors to tune into the media, which means higher ratings and revenues for them. It also pushes investors to make decisions based on emotions rather than long-term data. Activity enriches brokers and reduces returns. Here’s a glaring example, which is very relevant today:

When the markets crashed in 1973-74, most Americans agreed with economists who were predicting a massive depression. For the next five years, stock portfolios increased at a rate of approximately 25 percent a year!

The securities industry and the financial media work together to perpetuate the myth that someone out there has the ability to predict the direction of the markets. Hapless investors go from one “investment professional” to another seeking the holy grail: someone with predictive powers.

If you want to achieve your investment goals, you need to fundamentally change the way you invest.

Start by ignoring those who claim to be able to predict the future. They can’t. Market timing doesn’t work. Listening to their musings is harmful to your financial health.

Instead, focus on your asset allocation (the division of your portfolio between stocks, bonds, and cash). Invest in a globally diversified portfolio of low-cost stock and bond index funds. Many investors do not need a broker or an adviser to implement this Nobel Prize-winning strategy. I provide a road map to financial success, including the names of the index funds and fund families you should use, in my book “The Smartest Investment Book You’ll Ever Read.” And I have a simple, interactive asset-allocation questionnaire on my website, www.smartestinvestmentbook.com.

Dan Solin is a Senior Vice-President of Index Funds Advisors. He is the author of the New York Times best sellers The Smartest Investment Book You’ll Ever Read, The Smartest 401(k) Book You’ll Ever Read, and The Smartest Retirement Book You’ll Ever Read. . His latest book is Timeless Investment Advice.

Watch Dan on YouTube.

Follow Dan Solin on Twitter.

Read More:

529 College Savings Plans Are Best For Saving For Your Grandchildren’s College Education
Bonds and the Bonds Market: A Basic Primer
The Volatility Index – Much Ado About Nothing
Annuities: The Good, The Bad, and The Ugly

3 comments

  1. Editor, Equifax Personal Finance Blog says:

    "My father invests in stocks. He researches every day. I have bought stocks in the past, with varying results. The most important lesson I learned? If you want to be successful investing in the stock maket, it takes time, patience, and research."

    Tiffany commented on this post via Active Rain: http://activerain.com/blogsview/1817096/why-timing-the-stock-market-never-works

  2. gigascanner says:

    I'm sorry, but I beg to differ! Technical analysis really does work, and it really is possible to time the market. I've researched the problem for years, and have discovered / developed a couple of uncanny accurate signals for picking bottoms and tops, usually to the exact day. You can see them in action with our free chart-based stock screener.

  3. Nirman Broking says:

    Awesome post, I am an avid reader of your blog, keep on writing these great posts, and I’ll be a regular visitor for a very long time.
    Stock Market


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