Tigers, Fights and Why Market Timing Is Foolish
Today I'm going to talk about why trying to time the market is a foolish game.
Let's start with talking about the opposite, using a long term buy and hold strategy. When markets are in a long term bull market and pullbacks are small, sharp and ended quickly it is easy to be a buy and hold investor. The proliferation of the buy the dip mentality can be clearly seen in many investors since the GFC, even the remarkable crash and comeback we saw during Covid didn't deter investors from wanting to buy the dip.
Human beings are genetically hardwired to take action in the event of significant events or signs of danger. This probably goes back to our Neanderthal days when if our ancestors were faced with a hungry tiger standing still would result in not only death but the potential extinguishment of our genetic line.
So as a response we developed the famed flight or fight response. This is hard wired into our brains and shows up in our every day lives in numerous ways. I.e. if someone criticises you, your options are to bark back (fight) or stay silent/accept the criticism (flight).
Now this response occurs in your investing too. When markets fall our engrained nature is to either fight (buy more) or flight (sell as quickly as you can).
It feels almost unnatural to do nothing. Making a decision, even if in hindsight it is a mistake, feels better psychologically than sitting on our hands and not doing anything.
However, research over the years shows that investors who are willing to do nothing in periods of turmoil do significantly better over the long term. Look at the long term performance of a $100 invested in global markets for the last 100 years with dividends reinvested and the returns are outstanding.
In our daily lives, we all like to feel as though we are intelligent, powerful and capable of making outstanding decisions. Trying to time and trade markets (when you manage to pull it off) makes you feel all these emotions plus you get the satisfaction of outsmarting some of the most intelligent people in the world (professional investors).
Trying to time markets successfully over the long term is a mugs game. Let me explain a few reasons why this is the case (because I know you have seen ads somewhere about how using a couple of indicators you can time markets, make millions while working poolside 10 minutes a day).
Firstly, professional investors are incredibly smart people. In fact, I would argue that if you were to take only 40% of the hyper intelligent people working in finance away and have them working on endeavours more beneficial for humanity many of our greatest challenges would either be solved or immense progress would have been made.
Data, computer processing, the internet and quantitative/algorithmic trading has made it that those who want to trade are able to do so in microseconds. Seriously, look at how much many some hedge funds have paid to improve their connection to a stock exchange but fractions of 1/100th of a second.
Markets tend to price in most of the available information incredibly quickly and it makes it difficult to process this better than the geniuses and supercomputers.
Secondly you need to be correct an astronomical amount of time. No one makes perfect decisions 100% of the time. In order to time markets here are the decisions you need to make: your initial buy order, when to sell (the market could have a face ripping rally right after you sell), when to get back in (you might miss 10% of downside but if the market then falls another 20% you still lose). I know one investor that was fortunate enough to sell out their shares before the GFC but did not reinvest until 2015. This is an extreme opportunity cost.
A big part of this comes down to the underlying transaction costs incurred by routinely moving in an out of markets. For example you will pay brokerage commissions/costs (full disclosure I charge brokerage) and taxes. By trading assets over periods of less than 1 year you are increasing your tax liability on gains by incredible volumes.
Of course most brokers and stock trading platforms will encourage you to trade regularly. It's how they make their money. No wonder why I've seen ads that show it is so easy to trade that a baby could do it!
Thirdly, markets can move in incredibly unpredictable ways and there can be causes for extreme movements that many investors (even professionals) do not understand. Often we see some of the biggest rallies and best days for the market in periods where every signal is negative.
Rebalancing, adjusting and monitoring your portfolio is something that I could not recommend highly enough. Trying to make big predictions for crashes, booms and flat periods etc is something that I don't believe in.
My investment philosophy is focused more on looking at ways to build and preserve wealth over the long term. This means buying and holding quality assets, holding a diverse array of asset classes and not overtrading portfolios. It means rebalancing when necessary and most importantly not making extreme bets/predictions on what markets will do over the short term.