An easier way to look at market timing is that it’s the opposite of a buy and hold strategy. Instead of riding the market through its ups and downs and having faith in the long-term returns, market timing involves constantly buying and selling securities in attempt to beat the market.
The Dangers of Market Timing
For Gen Y investors, market timing is not worth the risk. Of course this is just my opinion, but I see many dangers for the individual investor to get involved with timing the market. The dangers of market timing include:
- Transaction Costs – If you’re trying to time the market, every time you make a trade, it’s another fee. One trade in a brokerage account will run you about $10. If you tried to time the market, you have to buy into the market for $10 and also have to sell out of the market for $10. Adding these fees up for multiple stocks, multiple times, takes a lot away from your overall return.
- Tax Inefficient - Once you sell a security for more than you paid for it, you have a taxable gain. Therefore, if you were to buy and sell the same security multiple times, you would have a taxable gain each time.
- Tax Document Overload – As a passive investor, I get little tax documentation at the end of the year. When I was young and over-confident that I can time the market, it was a nightmare at tax time. Sorting through 15 pages of my portfolio summary to get information was no fun at all. It costs me time and money because I had to pay for a tax preparer. This year, my portfolio summary was 3 pages.:)
- Information Overload - Timing the market makes you a slave to the news. The investors who succeed timing the market, (very few have succeeded) devote their life to market timing. Unless you have twelve hours a day to spare, you’re better off with a passive investment strategy.
- You Have To Be Right Twice – Market timing involves buying AND selling a security at the right time.
- There Are No Formulas – I have to admit, I enjoy watching infomercials that advertise a “proven system” to investing. If I had a secret, powerful, proven system to make millions of dollars, the first thing I would do is sell my system for not $500, not $400, not even $300, but 3 payments of $99.99. Don’t kid yourself, successful market timing doesn’t involve you sitting at the beach, sipping a cocktail. It’s a full-time job, with no guarantee of success.
- Miss Market Jumps – Nassim Nicholas Taleb in his book The Black Swan explains that the S&P, (the S&P 500 is the general benchmark for market returns) with reinvested dividends has returned about 9.5% over the past 30 years. However, if you were not invested during the 50 highest returning days, your total return is less than 1% for over 30 years! The market doesn’t move little by little, it moves by taking giant steps. If you miss out on those giant steps, which take place in a single day, you will lose.
When you add up these disadvantages, your chances to succeed are very small. Your best chance to succeed in investing, involves starting early, dollar cost averaging into the market, investing passively, and using tax advantaged accounts.