"Buy low, sell high". It sounds straightforward enough, and a fool proof way to make money. But life's rarely that simple, especially when it comes to financial markets.
Firstly, how do you know if a share or asset is ‘high’ or ‘low’. It's only framed by historic prices and various financial metrics that can change. If something looks cheap it can still get cheaper, and that which appears expensive can grow more so.
"Buy the dip" we are told, but what if the dip keeps dipping?
"You never go broke taking a profit" is another famous saying, but then if you sell and give up your position several things can happen. The asset carries on rising without you on board, or it falls, and you may (or may not) successfully time a re-entry.
These are just some of the complications investors get caught up in when trying to time markets and asset prices. It's deceptively difficult and often doesn't get you anywhere. That's because market tops and bottoms have much to do with human psychology, as well as many factors we aren't aware of at the time.
An unpredictable world
You can certainly accumulate when cheap and sell when expensive – on an entirely rational basis using historical averages or various metrics of valuation. But that’s not quite the same thing as market timing, and it won’t always help you, especially in the short term. The market can carry on doing its own thing. As John Maynard Keynes noted, “There is nothing so disastrous as the pursuit of a rational investment policy in an irrational world.”
The world is unpredictable, so it follows that if something happens it is not because it was the necessarily the most likely thing to happen, just one of the permutations of things that could have happened. Apply that to financial markets and overlay the sum of human emotions, greed and fear, towards them and you get an idea why timing the market, especially daily, weekly or monthly swings, is generally fool’s errand.
Timing is risky
For those who choose to consume it, financial news can be streamed 24 hours a day. Some people feel compel to act, to do something, especially when there is fear in the air and markets are falling. Yet investing is an unusual pursuit in that inactivity is frequently well rewarded. Provided you have a diverse and balanced portfolio it’s usually best to do as little as possible and simply let time do the hard work for you.
That’s because missing a few of the best days in the market can have a big impact on your overall long term returns. According to figures from BlackRock, and using the US S&P 500 Index, skipping just the five best days over the past 20 years would have slashed returns by more than 40%. The best days often follow some of the worst, making market timing all the more difficult. The sharp drop in share prices in reaction to the Covid-19 pandemic in 2020, and subsequent swift recovery, is just one example of how extreme market volatility can wrongfoot investors who are too reactive.
Alongside the risks and psychological challenges of market timing, selling and buying incurs transaction costs which are best minimised. Sitting out of the market also interrupts the flow of income from dividends and interest, which over the longer term represents a large portion of an investor’s return.
With all of these factors against market timing, selling your investments and sitting on the side lines temporarily can be fraught with danger.
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