Mark Hebner is the founder & President of Index Funds Advisors and in his book Index Funds-The 12-Step Program for Active Investors (2007 edition) he quotes a terrific study of how market timers fail miserably...
Mark quotes an analysis done by Robert Merton-the Nobel Laureate in Economics,
Writes Mark, (I have deliberately underlined some words to signify their importance)
Robert Merton wanted to estimate what a clairvoyant time picker would earn. To that end, he calculated the value of being invested in the market during upturns and T-Bills during downturns.
His findings show that investors who stayed invested in T-Bills from 1927 through 1978 would have seen their $1,000 investments grow to $3,600.
Meanwhile, in the broad market of the NYSE index, a $1,000 investment would have grown to $67,500 during the same period.
A time picker with the vision to forecast all the months that the NYSE outperformed T-Bills during the 52-year period would normally invest in the market at the beginning of each of these months. According to this timing system $1,000 would have grown to $5.36 billion.
Now that is a real incentive to figure out how to pick the right times to invest. It also proves that if timers really had psychic powers that allowed them to see next month’s market trends, they would grace the covers of Forbes, Business Week, and the Wall Street Journal. But, they do not.
Is it possible that there are a few visionary timers out there? Sorry, but they just don’t exist. In 1978, the wealthiest individual on record didn’t come close to these numbers. Wealth is not created by purposeful market timing. There may be cases where one got lucky for a while, but that is not a reliable strategy for long-term investors.
What does this mean?
* Timing the market correctly and consistently is an important component of active investing-in its attempt to beat the market (index) i.e. relative to a typically ‘buy-and-hold’ kind of passive investor.
* It implies that active investors have a huge incentive in forecasting (correctly) major turning points in the market.
* All of us have seen & read numerous studies which tell us something like this The market (index) gave a compounded annualized return of XYZ% (say) over the past 2 or 3 decades...and if an investor missed 10 or 20 or 30 best days (in trying to time the market) the return would have crashed to a measly ABC% instead of the XYZ% that an investor could have (otherwise) obtained by ‘buying and holding’ the market index.
A corollary to the above could be,
Had an investor stayed out of the market for the 10, 20 or 30 worst days over a 2 or 3-decade time period then that individual could have beaten the market (index) by a wide margin.
* The only catch is that the typical market timer, in order to be successful, would have to be a terrific ‘soothsayer’ possessing container loads of luck.
Conclusion: We know that the big moves in the market (both upwards and downwards) happen over a relatively small number of trading days-hence profitable market timing into the future (based on past data, models, and patterns) remains elusive and an utopian situation.
Successful market timing is therefore transient, mainly due to luck (or skill?) & an unreliable strategy, almost like throwing darts into the future!
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