Many investors ask: Does market timing work? We believe that market timing is a poor strategy to follow.

The practice of market timing consists of coming up with and acting on a series of guesses (or estimates, or assessments of the probabilities). You would use these in your buying and selling decisions, with the aim of buying near a low and selling near a high. Most market timing systems attempt to interpret and detect buy and sell signals in trading patterns and history.

Does market timing work? Some of the decisions you make with the help of market timing will bring you profits, but far more of them will cost you money.

Studies show stock market timing strategies consistently underperform the market

Dalbar Inc., a U.S. research firm, has studied actual investor returns for a number of years and has consistently found that investors fail to keep up with the market because they try to improve their returns through stock market timing.

The firm found that in the 20 years ending in 2008, the Standard & Poor’s 500 index had an average compound return of 8.35% a year. The average investor had an average hold period of three to four years within those two decades, and earned an average compound return of 1.87% a year. That’s a fraction of the gain in the market, and also well below the average inflation rate of 2.89%. Results for in-and-out bond investors were worse.

Does market timing work? No: Your bad decisions will far outweigh your good decisions
Many investors start out with an exaggerated idea of the value and importance of market timing. Most eventually become disillusioned with it, after they figure out that it’s costing them money.

Market timing can pay off sporadically, of course. Although the results are largely random, successes and failures are apt to run in spurts. The worst thing that can happen to you near the start of an investing career is that you make a series of successful timing decisions. This may lead you to believe that you have a natural talent for market timing, or that you’ve stumbled on a timing process that’s a guaranteed money-maker. Either of these conclusions can spur you to back your future timing decisions with growing amounts of money.

Good decisions based on timing often produce modest profits. They tend to be smaller than the losses you get from bad timing decisions. Needless to say, one of your future decisions is bound to turn out bad. If you’ve invested enough money in it, you could wind up losing much more than your accumulated winnings from prior timing-based decisions.

The best and worst advice for market timing

The best market timing advice we can offer is to buy steadily and carefully throughout your working years, and sell gradually in retirement. That approach is virtually certain to enhance your investing profits. For one thing, it stops you from selling all your stocks near a market bottom, which market timers do from time to time.

The worst market timing practice you can follow is to yield to hunches or jump to conclusions. I’m sure some skittish investors have been watching the market and trying to spot the next “correction” or temporary market setback. For them, a big drop in the Toronto index could be the start of a market setback. Of course, any market decline could be the start of a market setback.

Cut market timing risk by focusing on investment quality

Opinions always differ about what constitutes a high-quality investment. However, if you invest mainly in well-established, dividend-paying companies, you’ll find that your investment or market timing mistakes rarely lead to serious or permanent losses. If your stock market strategy focuses on spreading your money out across most if not all of the five main economic sectors (Manufacturing & Industry; Resources; Consumer; Finance; and Utilities), you’ll cut your vulnerability to market risk all the more.

In contrast, your market timing skills will always be crude and unreliable. They will never protect you from the risks of investing in companies with flawed business plans.

Moreover, even the best market-timing skills are useless when it comes to protecting you from untrustworthy insiders. If we have reason to doubt the integrity of a company’s insiders, we stay out, no matter how tempting it seems. There is no limit to the ways in which unscrupulous insiders can cheat you.

Has market timing ever been a focus of yours? Can you share an experience where you successfully timed the market and made money from it?

What would you say to a young investor who’s found success in timing the market? Should they change their investing strategy?