‘It’s about time in the market, not timing in the market’.

You have probably heard this saying plenty of times. But just how difficult (not to say impossible) it is to identify the best times and when to get out? And what’s the actual cost of getting it wrong? Here’s what research says.

The cost of missing the market’s best days

Perhaps, the most significant risk of market-timing is missing out on the market’s best-performing cycles. And according to a 2021 study by Putnam Investments, the best way to avoid this is to stay invested.

For illustration purposes, they considered someone who invested $10,000 in the S&P 500.

By staying fully invested over the prior 15 years (from 31 December 2006 to 31 December 2021), this investor’s fund value would have been US$45,682 (+10.66% annualised total return). That’s US$24,753 more than someone who tried to time the market but ended up missing the 10 best days. And of course, the more missed days, the steeper the loss.

Source: Putnam Investments, “Time, not timing, is the best way to capitalise on stock market gains”. Past performance is not a guarantee of future results.

And missing the best days is very easy

Bank of America calculated the impact of missing the market’s best and worst days each decade. What they found is eye-opening.

Looking at data going back to 1930, BoA estimated that if an investor missed the S&P 500’s 10 best days each decade, their return between 1930 and 2020 would only be 28%. And if you think that there are 3,650 days in a decade, you understand how easy it is to miss one out.

On the other hand, if the same investor held steady through the market’s best and worst days each decade (essentially just staying put), their returns would have been 17,715%. That’s 177 times what they initially invested, compared to 28% if they missed the best days.

Source: Bank of America, S&P 500. Past performance is not a guarantee of future results.

Even bad timing is better than no investments

In 2021, multinational financial services company Charles Schwab compared five investing strategies, looking for the one that was most likely to deliver higher returns over time.

They assigned each style to an imaginary investor. At the start of the year, for 20 years, each hypothetical ‘investor’ received $2,000 to invest in the sharemarket:

1. Peter Perfect, the perfect market timer, was able to invest his $2,000 every year at the lowest closing point;
2. Ashley Action consistently invested her $2,000 on the first trading day of the year, every year for two decades;
3. Matthew Monthly split his annual $2,000 in 12 equal portions and invested each at the beginning of each month (‘dollar-cost averaging’);
4. Rosie Rotten, a very bad market timer, invested her annual $2,000 each year at the market’s peak;
5. Larry Linger always left his money in cash investments and never invested in the sharemarket, as he was waiting for the ‘perfect time’.

Schwab then ran the numbers, and here are the study results:

Source: Schwab.com – Does Market Timing Work?

As you can see, the perfect market timer (who pretty much doesn’t exist) was the winner. But his returns were only slightly higher than Ashley Action, who invested immediately every year, or Matthew Monthly, who chose dollar-cost averaging.

As researchers put it, “Because timing the market perfectly is about as likely as winning the lottery, the best strategy for most of us mere mortal investors is not to try to market-time at all.”

And interestingly, Rosie Rotten’s bad timing was still a lot better than Larry Linger’s procrastination. Long term, researchers concluded, it’s almost always better to invest in shares – even at the worst time each year – than not invest at all.

The alternative to market-timing? Diversification.

As we’ve established, the perfect market timing requires two extremely difficult things: buying at the right time, and selling at the right time.

A more sustainable and cost-effective alternative is to buy and hold, with a well-diversified portfolio. Rather than trying to hide from market volatility, portfolio diversification is all about combining non-correlated asset classes to reduce overall volatility and, potentially, increase overall return over time.

Remember: diversification and time are an investor’s two best friends.

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Disclaimer: Please note that the content provided in this article is intended as an overview and as general information only. While care is taken to ensure accuracy and reliability, the information provided is subject to continuous change and may not reflect current developments or address your situation. Before making any decisions based on the information provided in this article, please use your discretion and seek independent guidance.