Market Timing: Is it worth it?

Market Timing: Is it worth it?

January 26, 2022

What a wild day for the markets, Monday, January 24, 2022, the S&P 500 was off by more than 10% from its recent record high. The Dow swung from negative by about 1,000 to closing positive by 100. Even with that positive close, both the Dow and the S&P 500 are on pace for their worst month since March 2020.

Correction territory with crazy market swings stirs news headlines and can quickly usher in feelings of panic and fear for some investors. Coupled with the current market volatility, recent COVID spikes, the probability of upcoming interest rate increases, and geopolitical risks, you can easily paint a clear picture of all the things that can go wrong to foster continued market volatility for 2022. So why not save yourself the headache of worrying about the market and maybe protect your portfolio from further downside? It sounds like a simple enough strategy; what could go wrong?

What is Market Timing?

Market timing refers to the investment strategy that attempts to predict a stock’s price movement or the overall investment market and position your assets accordingly. The hope is that your prediction is correct, and your investment actions have either made money or saved your portfolio from losses.  

Probability Points to Flaws in Market Timing.

I’ve been in the financial industry for over 25 years. Technology has created lots of robust financial software and instantly puts information at our fingertips. I am here to tell you that my ability to predict the market is only nominally better than my trusted magic eight ball. What would you say are my chances of picking both the highs and lows of the market? Statistically speaking, I don’t have a snowballs chance; and you know how the rest of that saying goes.

That’s just what you will need to do to time the market successfully. Once on the way out, and then on the way back in. Again, statistically speaking, difficult, especially repeatedly.

If the odds are stacked against your ability to time the market successfully isn’t enough to convince you, consider this; if you miss just a few of the market’s best days, you could lose a significant amount of money over the long term. Recent research, over a 20-year timeframe starting in January 2001, shows that the SP 500 returned an annualized 7.47%. That 20-year time included over 5,000 trading days. If you missed the ten best-performing days, the overall returns would drop to 3.35%. Ten days and you lost half of the annualized return. What happens if you miss another ten days, missing the 20 best performing days over the same 20-year period, the return is .69%. Heck, that is not much better than today’s money market rates. Missing a month of the best-performing days, it gets even worse; you are in negative territory. You get the point. Highlighting this further, the best market days in the market often come right after the worst. 

Possible Tax and Transactions Costs Could Make It Worse.

Market timing may not be the only thing that eats into your potential returns—depending upon the type of account, your cost basis, and the household income, you may have to consider tax consequences. If your investments are in taxable accounts (instead of tax-deferred accounts such as IRAs or 401ks), you may have to claim capital gains due to the sale. Taxation on capital gains is calculated based on your household income and the length of time you hold the investment. If you had the investment for less than a year, profits are subject to your ordinary-income tax rate instead of the favorable long-term capital gains rates. 

Also, by its very nature, market timing involves multiple transactions. Therefore, it may generate multiple recurring transaction costs. Certainly, an argument can be made that transaction costs have significantly declined over the years, some transactions may not even create a cost at all, but that doesn’t mean all transactions are free. If you consider market timing, you should verify your trading costs and understand that even small expenses can add up.  

The Takeaway

Managing uncertainty and keeping your emotions out of investing can be difficult. Understanding if reason or emotion oversees your wealth plan decisions is important. We know that it is hard to remain levelheaded and logical when headlines focus on the negative. On the emotional side of investing, it is essential to realize that you have your own goals, and your investments should be personal, not emotional. On the investment side, strategies exist to reduce overall risk.

As investors, you should expect crazy days and periods of negative returns periodically.  The best tools to combat it are to, ahead of time, know your risk tolerance, diversify your asset allocation, and focus on your long-term goals. If you need help, give us a call, that is our specialty.

This material is provided as a courtesy and for educational purposes only. Investing involves risk including loss of principal.  Please consult your investment professional, legal or tax advisor for specific information pertaining to your situation. This article contains links to articles or other information that may be contained on a third-party website.  River City Wealth Management is not responsible for and does not control, adopt, or endorse any content contained on any third-party website. The information contained herein is derived from sources deemed to be reliable but cannot be guaranteed. Past performance is not indicative of future results.

The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities that represent the stock market in general. The Bloomberg Barclays US Aggregate Bond Index is a broad base, market capitalization-weighted bond market index representing intermediate-term investment-grade bonds traded in the United States and is used for measuring the performance of the US bond market. Indexes are unmanaged and do not incur management fees, costs, or expenses. It is not possible to invest directly in an index. The MSCI EAFE Index is a stock market index that is designed to measure the equity market performance of developed markets outside of the U.S. & Canada. It is maintained by MSCI Inc., a provider of investment decision support tools; the EAFE acronym stands for Europe, Australasia and Far East.