The Pitfalls of Market Timing
Market timing is one of the most detrimental ways an investor can negatively impact his stock market returns. History shows that investors do not effectively time the market. For the last nine years, DALBAR, Inc., a market research firm, has conducted an annual study on market returns called the Quantitative Analysis of Investor Behavior (QAIB). This study has consistently found that returns earned by the individual investor are significantly below that of the stock market indices. The 2013 QAIB report found that during the 20 year period between 1998 and 2012, the average mutual fund investor lagged the stock market indices by 3.96%. This is a significant improvement over the period between 1991 and 2010, in which the average investor lagged the mutual fund indices by 5.1%. According to Dalbar, “No matter what the state of the mutual fund industry, boom or bust: Investment results are more dependent on investor behavior than on fund performance. Mutual fund investors who hold on to their investments are more successful than those who time the market.”
The stock market is counterintuitive in that the best time to sell is usually when the market seems to be doing well, and the best time to buy is usually when the market is doing poorly. As investors, our decisions are frequently driven by emotion rather than cognitive reasoning. We frequently overreact to emotions of fear and greed which throws numberswiki.com
us onto an investment roller coaster. When the stock market goes up we start to feel more and more optimistic, and as the market rises higher we get caught up in a state of euphoria. Our sense of greed kicks in and we don’t want to miss the opportunity to make money, so we buy when the market is high. The market may stay up for a while but eventually the economic cycle changes and stock prices start to drop. Initially we rationalize that this is temporary, or just a minor correction. As the market continues to drop we become more and more concerned. Soon our sense of fear kicks in, we start to panic and we sell at the wrong time. If we don’t recognize the dangers of this emotion driven cycle we are deemed to repeat it.
In addition to our intrinsic emotional response, we are bombarded by sensationalized news and advertising campaigns to influence us to change the course of our investment strategy. Don’t get caught up in the hype about the next big investment craze. Your best course of action is to develop and follow an investment strategy that supports your tolerance for risk and investment timeframe. The stock market is volatile and is best suited for long term investing. Time is needed to absorb fluctuations in the market. Keep short term money in fixed income investments. You will be less tempted to time the market in a well-diversified portfolio specifically designed for your investment time horizon.