Timing the market refers to buying securities when the price is low and selling them when the price is high. Trying to time the market can be tempting because it might seem like you can make a lot of money, but it’s not without risks.
Buy low, sell high. While it’s simple in theory, in reality, it’s highly unlikely you will be able to time the market successfully. Chances are, you will buy things you think will increase, but it never happens. Then you’re left selling it at a loss. This scenario is all too common, and it’s why you should avoid trying to time the market.
While you could try to time the market, it’s better to avoid it in most cases. Fortunately, there are several alternatives to it instead. Depending on your goals, one of the alternatives might be a better choice.
The problem with timing the market
Timing the market is difficult. Actually, that is probably an understatement as very few people can time the market consistently. In fact, even professionals who try to time the market usually fail. For instance, a report from Dow Jones showed that over a 20-year period, fewer than 10% of actively managed U.S. stock funds managed to beat the index.
There is much potential to lose money when market timing. You would obviously lose money if you have to sell stocks or other securities at a loss because the price fails to increase.
But even buy-and-hold inventors can lose money trying to time the market. Charles Schwab ran a scenario that compared five different investors. It gave them $2,000 every year for 20 years. It found how much money they would each have at the end:
- An investor with perfect market timing: $151,391
- An investor who immediately invested their money: $135,471
- An investor who performed dollar-cost averaging: $134,856
- An investor with bad market timing: $121,171
- An investor who left their money in cash: $44,438
In the experiment, the investor with perfect market timing did, in fact, fare the best. But the second-best result was from the investor who immediately invested their money, paying no attention to market timing. And the second-worst investor was the one with bad market timing.
This example illustrates why market timing is a bad investment strategy. The vast majority of investors who try to time the market fail. That means that after 20 years, your portfolio is more likely to look like the second-worst result above. But if you immediately invest your money in a low-cost index fund, you will likely be among the best performers in the long term.
Alternatives to market timing
Timing the market can be tempting, but it’s not a viable long-term strategy for most investors. Fortunately, several alternatives can produce better results.
Diversifying your portfolio means maintaining a portfolio of several assets, such as stocks, bonds, real estate, and cash. This approach has several benefits, including spreading your risk across multiple assets.
In addition, investing in several types of assets gives you exposure to different markets, which can have negative correlations with one another. This helps protect you against volatility as you aren’t concentrated in a single type of investment. Diversifying your portfolio can give you better results while reducing your long-term risk.
As we saw in the example above, dollar-cost averaging doesn’t always produce the best results in the long term. However, investing all your money immediately can be scary. It can feel like you are giving up control of your portfolio, and not all investors are comfortable with that.
That’s where dollar-cost averaging comes in. Rather than invest all your money immediately, you invest periodically, such as once per month. The idea behind this strategy is to avoid the possibility that you just happen to invest your lump sum when the market is at its high point for the year. Instead, you would get exposure to a variety of market conditions, thereby producing better results overall. Again, it may not always beat investing right away, but it’s still better than trying to time the market in most cases.
If you want your portfolio to grow, one of the most important things to do is invest for the long term. A great way to understand why this is important is to look at this graph of the S&P 500. Looking at this graph, we can see that the broad stock index has had many ups and downs in the past 70 years. The S&P 500 is often used interchangeably with the overall market. When someone asks “how the market did today,” they’re typically referring to the S&P 500.
Even though the market has had many big drops in that time, it has always recovered, eventually moving higher than its previous high. Simply keeping your money in the market will allow you to take advantage of this growth. While the big drops can seem scary, history has shown that the market always recovers, only to come back stronger.
A popular expression in personal finance communities is, “time in the market beats timing the market.” Timing the market can be tempting, but it’s not a viable long-term strategy for most investors. For most of us, combining a diversified portfolio with long-term investing is best. In addition, it would be wise to meet with a financial advisor who can help you set up a portfolio tailored to your situation.
Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past investment product performance is no guarantee of future price appreciation.