Market volatility can be overwhelming, leading some investors to head for the exits and sit in cash. While this seems like a prudent way to reduce risk, it usually does the opposite, turning temporary losses into permanent losses.
The experience of investing teaches us important lessons about the dangers of market timing such as:
Market losses are rare, short-lived, and impossible to reliably predict.
Usually the stock market is like a runaway train, making new all-time highs and rarely revisiting old levels. When a large drawdown occurs, the cause-and-effect logic often seems obvious after the fact, but this is an illusion. Because of a behavioral bias known as hindsight bias, we often think that in the past we predicted the present, and therefore we convince ourselves that we can predict the future. This bias comes in part from the fact that we often struggle to remember our failed predictions.
Bear markets offer a rare chance to buy at “ yesterday’s prices.”
Bear markets (episodes where the S&P 500 falls more than 20%) are a time period that captures drawdowns in history. These are historically the only times that markets can offer an opportunity for investors to buy stocks at levels that haven ’ t been available for several years.
Market timing doesn’t add value unless everything goes right.
In order to add any value versus a buy-and-hold strategy, you would need to sell
high and buy low with the right timing. If you sell too early or buy too late, you risk missing out on gains that could exceed any potential market-timing profit you might have hoped for. Outside of bear markets—which are rare, occurring about seven years apart, on average—almost all market selloffs are so short-lived that would-be market timers are left with proverbial whiplash.
Diversification changes the game.
In real life, it’s fortunate that investors have more investment choice than just the S&P 500 or “all-in” or “all-out”. A balanced portfolio —e.g., 60% stocks, 40% bonds — has historically produced growth that is far more durable and reliable than a 100% investment in stocks: shallower drawdowns, faster recovery times, and more durable bull market gains.
While market timing can be tempting— both for investors looking to boost their returns and those looking to limit their losses — its imagined benefits are ultimately a mirage.
The phrase “buy low, sell high” may sound clever, but it has historically proven to be a fallacy because most investors tend to overestimate how much they stand to gain from market timing, and tend to underestimate the cost of waiting for a pullback.
-Tasha Bremel, Vice President – UBS Financial Services Inc. Wealth Management Americas
