Importance of Market Timing

Market timing is the act of moving in and out of the market or switching between asset classes based on using predictive methods such as technical indicators or economic data. Because it is extremely difficult to predict the future direction of the stock market , investors who try to time the market, especially mutual fund investors, tend to underperform investors who remain invested.

Trying to navigate the peaks and valleys of market returns, investors seem to naturally want to jump in at the lows and cash out at the highs. But no one can predict when those will occur. Of course we’d all like to avoid declines. The anxiety that keeps investors on the side-lines may save them that pain, but it may ensure they’ll miss the gain. Historically, each downturn has been followed by an eventual upswing, although there is no guarantee that will always happen. Trying to avoid risk could itself be risky, since it’s impossible to know when to get back in.

Rather than fretting about when you should make that first stock purchase, think instead about how long you’re planning to keep money in the market. Different investments offer varying degrees of risk and return, and each is best suited for a different investing time frame. Once you’ve decided what to buy, and when to buy it, you’ll next need to decide when to cash out. Since bonds essentially sell themselves when they mature, this question primarily applies to stocks or stock mutual funds.

Some investors believe they can “time” the market, accurately predicting when it will rise and fall. As a result, they counsel selling all your stocks when the market is about to fall, and buying them all back when the market prepares to rise. Unfortunately, if investing were that easy, these same folks would be sunning themselves on beaches in Acapulco, rather than trying to sell their timing methods to other investors.

Granted, when overall economic woes begin to hurt corporate earnings growth, and companies start to flounder, you might consider selling some of your overvalued, lower-quality companies. But beyond that very general scenario, an accurate system for timing the market remains an investor’s pipe dream. Many mutual fund investors are quick to withdraw their cash when returns turn sour. But several academic studies have proven that investors who jump from one fund to the next, chasing performance, tend to do vastly worse than those who stay put. Be prepared to stick with a fund through good times and bad — with one exception.

The stock market and the overall economy are virtually impossible for economists to forecast because they depend upon unpredictable factors that are outside their control. Your own personal financial situation, on the other hand, has far fewer unknowns. For that reason, it is possible, and may indeed be very rewarding, to make predictions and to time important financial decisions to your advantage.