For many New Zealand investors, the idea of timing the market – selling high and buying low – is as enticing as catching the perfect wave. Looking at a chart of the market index, it’s hard not to wonder what if one can sell high and buy low on every crest and trough along the way, a trading approach rather than buy-and-hold investing? While the appeal is obvious, the reality is far more complex.
Rational allure
Market timing can take several forms. It may involve moving between asset classes, shifting from equities to cash or bonds when markets look risky.
It can also mean rotating between varying sectors or styles such as switching from defensive, dividend paying businesses, to smaller, high growth firms. More active investors might also adjust between fixed interest securities of varying quality or between investing styles altogether.
The motivation is often rooted in protecting capital during downturns and enhancing returns during flat or volatile periods. This is understandable, especially for people approaching retirement or managing long term savings through KiwiSaver. The pain of losses tends to loom larger than the joy of equivalent gains – a concept well documented in behavioural finance.
However, investors must pause and ask themselves if they are making decisions based on a shift in their investment goals or risk appetite, or they are simply reacting emotionally to market noise. If it’s the latter, it might be time to re-evaluate the portfolio rather than attempt to time the market.
The crystal ball problem
Timing the market assumes an investor can reliably forecast what comes next, whether it’s a major global event, economic downturn, or central bank move.
Even if you successfully predict a market drop and sell in time, you face a second challenge – when to get back in. This is known as ‘closing the loop.’
Without a clear plan to re-enter the market, investors risk missing the recovery, often the most profitable period. In practice, many who exit due to fear wait too long to return, buying back in after markets have already rebounded.
Economist John Maynard Keynes said: “Many of those who attempt [market timing] sell too late and buy too late and do both too often.”
How good is your crystal ball? Do you have one? The odds of getting both calls optimal are low. Attempting to do this repeatedly for all bear markets will invariably result in some trades not working.
The cost of missing the best days
Market volatility tends to come in waves and some of the biggest up days follow immediately after sharp declines. A recent study shows that missing just 40 of the best performing days over a 24-year period is enough to reduce an investor’s return to zero – that’s just 0.5 per cent of the trading days.
Furthermore, the detrimental impact is even greater in a low return environment – imagine if the market only returned 7% rather than 9% over time.
Being a bad trader in flattish markets is more painful than in upward trending markets.
Of course, avoiding the worst days would help returns, but predicting both the peaks and troughs consistently is near impossible. Since large up and down days tend to cluster together, it’s extremely difficult to catch one without being exposed to the other.
Systematic rebalancing
Rather than attempting to predict the next move, investors might consider systematic rebalancing.
This approach involves periodically adjusting your portfolio back to a strategic asset allocation based on long term goals and risk tolerance.
For example, if equities have outperformed and now represent a greater share of your portfolio than intended, you would sell some and reinvest in other assets such as bonds or cash.
Conversely, during a market dip, rebalancing may prompt you to buy more equities at lower prices. In effect, you’re buying low and selling high, but doing so in a structured, emotion-free way.
Caution over confidence
The idea of outsmarting the market is tempting, especially when volatility increases or headlines become pessimistic. But history and data suggest that consistent success at market timing is rare and often requires more luck than skill.
If investing is more an art than a science, then market timing would fall into the realm of the dark arts – it’s difficult to master and fraught with pitfalls.
For those without a crystal ball, which means most of us, the best course may be to stay the course.
Felix Fok, Director, Wealth Research, Jarden Wealth. Jarden Wealth is part of FirstCape Group. From August Jarden Wealth will be rebranding to JBWere NZ.
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