How 'market timing' can cost you | BetaShares

How ‘market timing’ can cost you

BY Richard Montgomery | 9 September 2020
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How market timing can cost you

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Many investors go to a lot of effort trying to pick market (or individual share price) lows and highs, in an attempt to time their entries and exits. It’s a strategy that often goes hand-in-hand with a willingness to take investment decisions based on relatively short-term market movements.

This approach is sometimes referred to as ‘market timing’, and it contrasts with a long-term buy and hold approach, where an investor may not be so fixated on price when first investing, and typically buys with the intention of holding for a period of years.

Whilst simple in concept, in practice market timing is not so easy. The problem is that, as an old saying goes, no-one rings a bell at the top and the bottom.

Does timing really matter?

There are many studies, conducted over a range of timeframes and in sharemarkets around the world, showing the impact on investment returns of missing out on the best few days for the market in a given period. These studies consistently show that not being invested on just a few of the big ‘up’ days for the market can have a dramatic impact on your portfolio.

One study looked at the U.S. sharemarket over a period of nearly 40 years, and calculated the impact of missing the best 5, 10, 30 and 50 days in that period.

An investor who hypothetically invested $10,000 into the S&P 500 Index on 1 January 1980 and remained fully invested would have seen their money grow to almost $660,000 by 31 December 2018.

Missing out on just the five best days during that period would have reduced their returns by 35%, while missing out on the 10 best days would have cut returns by more than half.

Hypothetical growth of $ invested in S&P 500

Source: www.fidelity.com. Hypothetical example provided for illustrative purposes only. You cannot invest directly in an index. Past performance is not indicative of future performance.

Looking at the Australian sharemarket, a hypothetical $10,000 invested into the S&P/ASX 200 Accumulation Index on 30 October 2003 would have turned into $38,002 by 3 August 2020.

Missing the 10 best days during this period would have reduced returns by $15,484, while missing the 20 best days would have reduced returns by $23,0931.

These examples illustrate the risk you take by trying to ’time the market’. Who knows when those good days, that make a disproportionate contribution to long-term returns, will take place?

Actually, there is a partial answer to this exact question that reinforces the problems with attempting to time the market: many of the best days in the market come right after the worst days.

We saw examples of this on the ASX earlier this year when the market was at its most volatile:

  • a fall of 9.7% on 16 March was followed by a rise of 5.8% on 17 March
  • after the market fell by 5.6% on 23 March to hit its 2020 low, on the following three days it rose by 4.2%, 5.5% and 2.3%
  • a fall of 5.3% on 27 March was followed by a rise of 7.0% the next trading day2.

These figures tell us that it is during the very times that markets are at their most stomach-churning, and investors are most likely to be panicked into cashing out of their investments, that the most important up days may be about to occur. These are the days that make outsized contributions to your long-term returns.

Of course, remaining invested means you also remain exposed to the market’s bad times.

What is the lesson?

The key lesson is that it is almost impossible to consistently time the market over the long term.

While everyone’s circumstances and goals are different, conventional wisdom is that most investors are best-advised to play a long game, get their asset allocation right, and ensure they are well-diversified.

ETFs are well-suited to this investment approach. They provide a convenient, cost-effective way to get exposure to all the major asset classes, including Australian and global equities, fixed income, cash and commodities.

You can use ETFs to build the core of your portfolio – investments that will provide your portfolio foundation over the long term, through the market’s up and down cycles. For example, the BetaShares Australia 200 ETF (ASX: A200) provides exposure to the largest 200 companies on the ASX at an annual management cost of just 0.07%3.

So should I ever attempt to time the market?

By now it should be clear how difficult it is to time the market – and the risks you run if you get it wrong.

However, that’s not to say that you should ignore market valuations, and adopt a ‘100% invested, 100% of the time’ approach.

Just as some fund managers take an ‘overweight’ or ‘underweight’ approach according to their market view, you can also adjust your exposure. Rather than selling everything when you think the market is getting ‘toppy’, you may consider banking some profits by selling a portion of an investment. Similarly, when the market has suffered a significant pullback like we saw earlier this year, if you think that a recovery is likely, you can top up holdings, or take the opportunity to add a new investment to your portfolio.

This is very different from an ‘all in or all out’ approach. If you get the timing right, you can enjoy a boost to your portfolio returns – and if you don’t, at least taking an incremental approach means there won’t be a catastrophic impact on your portfolio.

Of course, the approach you take should ultimately be informed by your personal objectives, financial situation and needs, and you should consider obtaining financial advice before making any investment decision.

You can check out the range of BetaShares ETFs here.


1. Source: www.fidelity.com.au. Hypothetical example provided for illustrative purposes only. You cannot invest directly in an index. Past performance is not indicative of future performance.
2. www.asx.com.au, movements in the S&P/ASX 200 index
3. Other fees and costs, such as transactional costs, may apply. Refer to the PDS for more information.

12 Comments

  1. Rob O'Donnell  |  September 9, 2020

    Show me the impact of missing the worst days as well or you lose any credibility!

    1. Richard Montgomery  |  September 9, 2020

      Thanks for your comment, Rob. As the article stated, remaining invested means you also remain exposed to the market’s bad times. And as you point out – if you were able to miss out on the worst days, your portfolio would benefit enormously. However, as no-one so far has been able to work out a way to identify in advance either the best OR the worst days, the problem is that in trying to avoid the latter you run a high risk of also missing out on the former.

  2. Frank Watkins  |  September 9, 2020

    Many will disagree with this long term approach. Timing is everything. Using the Accumulation Index is OK if you are using a derivative of that index, otherwise there is a definite flaw in that bad stocks are kicked out of the index and replaced by a better stock. Here we are today close to 1000 points below the 2007/8 high. So when you guys are doing the research on this stuff, what do you pick as a starting point for your demonstration, the lows?. (I guess you are still holding Telstra?)

    1. Richard Montgomery  |  September 9, 2020

      Hi Frank, thanks for your comment. You’re right – many will disagree, the amount of effort expended on trying to do exactly that (time the market) is testament to that. The article was intended simply to convey the risks you run in trying to do so. If you are able to successfully time the market consistently over the long term, then the rewards will indeed be high. The strategy of adopting overweight/underweight positions that we concluded with is, when you think about it, a form of market timing – just not an ‘all in, all out’ approach. (And yes, while I sold half my Telstra, I’m afraid I still hold the other half!)

  3. Interesting analysis! Though to be complete, it would be useful to compare 2 other scenarios: 1 with “missing the worst 5,10,30 50 days”….and the other perhaps more realistic for market timing followers is “missing both worst and best 5,10,30,50 days”.

    1. Richard Montgomery  |  September 9, 2020

      Thanks for your comment, Aseet. The first analysis you propose has indeed been done, I’m not sure about the second. As you would expect, missing the market’s 10 worst days has a massive beneficial impact on your portfolio – some studies suggest even a greater impact than the negative impact of missing the 10 best days. I think the key point is that it’s just as hard to pick the market slumps as it is to pick the days the market goes on a tear, and so the chances of being ‘out’ on exactly the right days are about as low as the chances of picking the days to make sure you’re ‘in’. If only we could do both!

  4. James Rees  |  September 9, 2020

    I believe the point of the article is valid and there is some great data to support the idea that trading in and out of the market is likely to be detrimental to performance.

    But using the theoretical performance of missing the best 5 trading days is not really reflective of anything. The chances of actually missing the best 5 trading days from 1980 – 2019 is approximately 1 in 84 quintillion.

    1. Richard Montgomery  |  September 9, 2020

      Thanks for your comment, James. I’m not sure how many zeroes there are in a quintillion, but it sounds like a lot. While my ability to deal with zeroes stops way before that, would I be right in thinking that 1 in 84 quintillion refers to the probability of being out of the market for ONLY those exact best five days over the course of 39 years? I don’t think anyone is suggesting an investor could be so unfortunate as to trade out of the market the day before each of the five best days in 39 years and back in the day after – it was just used to illustrate the dramatic effect the best days have on overall returns. I think the general point is that if you were out of the market for longer periods, in which those best days fell, your returns would most likely suffer.

  5. People in these comments are missing the point.

    Most importantly, the tax implications of jumping in and out erode profitability over staying in, there are case studies on that.

    You are unable to know when the best days will be. However, you can look at what the value of what you are investing is at the time you are wanting to put money in and decide if it’s overpriced or underpriced.

    Case studies show dollar cost averaging wins.

    1. Richard Montgomery  |  September 9, 2020

      Thanks for your comment, Mark. And yes, tax is another consideration to factor in.

  6. Ian Duncan  |  September 10, 2020

    Interestingly research shows that the best days often occur during a downturn and that being out of the market for most of that downturn and going back in when the market starts a new uptrend gives a better result than staying in. Buy and hold is OK when the market is trending up or moving sideways but definitely not as good as timing when there is significant downturn like we’ve just had. I have used timing using an ASX 200 ETF for many years and assure you that I am way ahead of where I would have been with a buy and hold strategy. The ASX 200 is still about 1000 points below the level just before the GFC – that’s 11 or 12 years ago!

    1. Richard Montgomery  |  September 10, 2020

      Thanks for your comment, Ian. I’m glad to hear you’ve had success with timing the market in your own investing! You’re right of course: “being out of the market for most of that downturn and going back in when the market starts a new uptrend gives a better result than staying in”. The problem is – how do you know when the market is about to start its downturn? How do you know when it’s finished its downturn, and is about to begin an uptrend? There’s no argument that market timing produces superior results if you get the timing right – but it’s that very big ‘if’ that is the challenge!

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