Over the course of a summer, it’s not unusual for the stock market to come up during barbecues or social gatherings. A neighbor or relative might ask, “Which investments are good right now?”
The temptation to time the market—buying in at the right moment or avoiding the next downturn—can even affect disciplined, long-term investors. But successfully timing the market isn’t as simple as it sounds. Often, the anxiety of being in the market is quickly replaced by the anxiety of being out of it.
OUTGUESSING THE MARKET IS DIFFICULT
Trying to buy individual stocks or make tactical allocation changes at precisely the “right” time presents substantial challenges. Markets are incredibly competitive and adept at processing information.
In 2018, global equity trading averaged $462.8 billion daily.[1] With this volume of activity, market prices quickly incorporate available information, from economic data to investor sentiment. By the time an investor reacts to the morning news or a financial TV segment, it’s likely that information is already reflected in prices.
Even professional investors struggle to outperform. Over the last 20 years, Dimensional’s research found that 77% of equity funds and 92% of fixed-income funds failed to outperform their benchmarks after costs.[2]
Attempting to buy individual stocks or make tactical asset allocation changes at exactly the “right” time presents investors with substantial challenges. First and foremost, markets are fiercely competitive and adept at processing information. During 2018, a daily average of $462.8 billion in equity trading took place around the world.[1] The combined effect of all this buying and selling is that available information, from economic data to investor preferences and so on, is quickly incorporated into market prices. Trying to time the market based on an article from this morning’s newspaper or a segment from financial television? It’s likely that information is already reflected in prices by the time an investor can react to it.
Dimensional recently studied the performance of actively managed mutual funds and found that even professional investors have difficulty beating the market: over the last 20 years, 77% of equity funds and 92% of fixed income funds failed to survive and outperform their benchmarks after costs.[2]
Challenges of Market Timing
Market timing requires getting two decisions right: when to sell and when to buy back. Nobel laureate Robert Merton explained the difficulty succinctly:
"Timing markets is the dream of everybody. But even if I were a .700 hitter in calling market turns—which is extraordinarily good—I’d have less than a 50-50 chance of getting both decisions right."
The inherent uncertainty makes market timing a challenge for even the most experienced investors.
What History Tells Us
The S&P 500 Index has logged an impressive decade. Does this mean investors should reduce their equity exposure? History suggests otherwise.
Exhibit 1 shows that new market highs have not been predictive of negative returns. Instead, the S&P 500 delivered positive average annualized returns over one, three, and five years following new highs.
This underscores a critical point: while past performance doesn’t guarantee future results, new highs don’t necessarily signal trouble ahead.
Exhibit 1. Average Annualized Returns After New Market Highs [3]
S&P 500, January 1926–December 2018
Focus on What You Can Control
Outguessing markets is harder than it seems, and there’s little evidence it can be done reliably, even by professionals. The good news? You don’t need to time markets to have a successful investment experience.
Capital markets have historically rewarded disciplined, long-term investors. By focusing on controllable factors—such as maintaining an appropriate asset allocation, diversifying, and managing expenses, turnover, and taxes—you can position yourself to make the most of what markets have to offer.
CONCLUSION
The allure of timing the market is powerful, but it’s a strategy fraught with challenges. Instead of trying to outguess markets, focus on building a long-term plan that aligns with your goals and risk tolerance. A disciplined approach, combined with careful attention to the things you can control, can help you stay on track and avoid the pitfalls of short-term noise.
*Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio.
Past performance is not a guarantee of future results. Diversification does not eliminate the risk of market loss.
There is no guarantee investment strategies will be successful. Investing involves risks, including possible loss of principal. Investors should talk to their financial advisor prior to making any investment decision. There is always the risk that an investor may lose money. A long-term investment approach cannot guarantee a profit.
All expressions of opinion are subject to change. This article is distributed for informational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products, or services.
Robert Merton provides consulting services to Dimensional Fund Advisors LP.
[1]. In US dollars. Source: Dimensional, using data from Bloomberg LP. Includes primary and secondary exchange trading volume globally for equities. ETFs and funds are excluded. Daily averages were computed by calculating the trading volume of each stock daily as the closing price multiplied by shares traded that day. All such trading volume is summed up and divided by 252 as an approximate number of annual trading days.
[3] In US dollars. Past performance is no guarantee of future results. New market highs are defined as months ending with the market above all previous levels for the sample period. Annualized compound returns are computed for the relevant time periods subsequent to new market highs and averaged across all new market high observations. There were 1,115 observation months in the sample. January 1990–present: S&P 500 Total Returns Index. S&P data © 2019 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. January 1926–December 1989; S&P 500 Total Return Index, Stocks, Bonds, Bills and Inflation Yearbook™, Ibbotson Associates, Chicago. For illustrative purposes only. Index is not available for direct investment; therefore, its performance does not reflect the expenses associated with the management of an actual portfolio. There is always a risk that an investor may lose money. Disclaimer: This content is for informational purposes only and is not intended as personalized financial, tax, or investment advice. While we strive to provide accurate and up-to-date information, all investments carry risk, and past performance is not indicative of future results. Any strategies or insights discussed may not be suitable for your specific situation. If you’d like to discuss how this applies to your financial plan, feel free to reach out.