Have you ever tried to time the market?
I'll admit that I have.
At various times over the past many years, I've watched the S&P/ASX 200 Index (ASX: XJO) and S&P 500 Index (SP: .INX) hit a tough patch and drop by 4% or 5%. And based on my own analysis, I expected the markets to fall further before rebounding.
So, I kept some ready cash on the sidelines in hopes of timing the market and going all in right at its lows.
While I did manage to get back in close to the lows on a few occasions, more often than not I ended up watching the market rebound with my investment money still waiting in the bank.
And this, according to Shane Oliver, head of investment strategy and chief economist at AMP Ltd (ASX: AMP) counts as one of the crucial mistakes investors often make that keep us from reaching our financial goals.
Oliver cites a great quote on timing the market by fund manager Peter Lynch to highlight the potential costs of this mistake.
"Far more money has been lost by investors in preparing for corrections, or anticipating corrections, than has been lost in the corrections themselves," Lynch said.
How timing the market can diminish your returns
"In the absence of a tried and tested process, trying to time the market, i.e., selling before falls and buying ahead of gains is very difficult," Oliver said.
Now, timing the market right would certainly increase your returns. But good luck.
According to Oliver:
Of course, if you can avoid the worst days during a given period, you will boost your returns. But this is very hard, and many investors only get out after the bad returns occur, just in time to miss out on some of the best days and so hurt their returns.
He added that, "Perhaps the best example of this is a comparison of returns if the investor is fully invested in shares versus missing out on the best days."
So, what do the numbers show?
Oliver said:
If you were fully invested in Australian shares from January 1995, you would have returned 9.5% pa (including dividends but not allowing for franking credits). But if by trying to time the market you miss the 10 best days the return falls to 7.5% pa. If you miss the 40 best days, it drops to just 3.5% pa.
Hence, it's time in the market that's the key, not timing the market.
The last two years provide a classic example of how hard it is to time markets – there has been a long worry list, so it's been easy to be gloomy but timing markets on the back of this has been a loser as shares put in strong gains.
So, how can ASX 200 investors avoid the urge to try timing the market?
"The easiest way to overcome many of these mistakes is to have a long-term investment plan that allows for your goals and risk tolerance and then stick to it," Oliver concluded.
