The Perils of Market Timing 

Kristina Hooper 

The Upshot 

2/18/2014 

Long-term investors should resist the urge to react to short-term market moves and stay invested in the stock market. Jumping in and out of stocks can be hazardous to the health of their portfolios, writes Kristina Hooper.
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Kristina Hooper, US investment strategist and head of US Capital Markets Research & Strategy for Allianz Global Investors. She has a B.A. from Wellesley College, a J.D. from Pace Law and an M.B.A. in finance from NYU, where she was a teaching fellow in macroeconomics.

Timing the stock market can be a dangerous game that long-term investors should avoid playing. Not only is it difficult to get it right, but the time spent on the sidelines waiting for “the right moment” could pose big risks to your portfolio.

Stocks continued their winning streak on Friday, capping a two-week rally that saw investors cheer new Fed Chair Janet Yellen’s testimony and overlook some weak economic data. In fact, it was the best week for stocks we’ve seen so far in 2014. In January, investors seemed gloomy on the stock market but lately their outlook has been more upbeat. That shift in sentiment is likely being driven by an easing of risks to the recovery, specifically lawmakers’ efforts to avoid another debt-ceiling showdown. In fact, the president signed a bill lifting the debt limit on Saturday, freeing up the Treasury Department to borrow regularly through March 15, 2015.

A Fickle Lot

What a difference a few days make, not just for performance but also for fund flows. Investors reportedly pulled a record amount of money out of US equity funds and put a record amount of money into US bond funds for the week ending Feb. 5. That followed significant equity fund outflows for the week ending Jan. 29, according to Deutsche Bank citing EPFR data. However, in the past week, likely due to the turnaround in the stock market, more than half of that move was reversed.

… investors do themselves a disservice by letting short-term market gyrations affect their investment decisions.”

Still, the volatility in weekly fund flows serves as a reminder that markets can be fickle and that investors may be doing themselves a disservice by letting short-term market gyrations affect their investment decisions. In fact, given recent volatility, Allianz Global Investors’ Economics & Strategy Group, which analyzes economic and capital-market trends, took a fresh look at the effects of market timing on an investor’s portfolio. We found that timing over longer investment horizons can lower returns by missing high-return days when moving in and out of the stock market.

Time In the Market

Specifically, Allianz Global Investors looked at the performance of the Datastream US Total Market Total Return Index from 1973 through the end of 2013, comparing four different investment approaches:

1. Investing $100 at the start of the first year and adding an additional $100 at the start of each subsequent year.
2. Investing $100 on the day of the lowest index level of the year and adding an additional $100 each year on the day of the lowest index level of that year—the best day of the year to invest.
3. Investing $100 on the day of the highest index level of the year and adding an additional $100 each year on the day of the highest index level of that year—the worst day of the year to invest.
4. Investing $100 each year at the start of the year as in the first approach, but assuming one misses the returns of the best three trading days in each year.

Market Timing Chart


The result? The returns are actually quite similar for the first three approaches. The first approach yields an annualized return (adjusting for all the $100 injections) of 11.6% while the second approach yields an annualized return of 11.9%. The third approach produces an annualized return of 11%. While these approaches are all within striking distance of each other, the hypothetical fourth approach produces dramatically lower performance: an annualized return of just 1%.

A Fool’s Errand

The key takeaways from this study are simple: Investors with long time horizons would be wise to avoid timing the market because our research shows that it doesn’t make a significant positive impact on performance in the long run. And market timing can lead to poor results. For example, investors can miss the best days in the market in a given year, substantially reducing their overall performance. On the other side of the coin, missing the worst days in the market could improve overall performance. However, it’s unlikely that investors would guess correctly.

So, for those who already have adequate exposure to stocks, it’s not a prudent investment decision to time the market and move out of stocks with each little correction. You may find that you’ll re-enter the stock market at higher prices. After all, it’s nearly impossible, if not impossible, to perfectly time the market. And if you don’t have enough exposure to stocks and you’re looking for an attractive entry point, worry less about the actual timing. Rather, consider rotating into stocks. Why? Because the biggest risk may be not having exposure and missing out on the best days. In short, our research confirms a key message we’ve been trying to impart to long-term investors: it may be too risky not to be in risk assets.


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Investors should consider their individual goals, investment time horizon, financial status and risk tolerance and should consult with their financial advisor when making asset allocation decisions. Unlike cash and fixed-income securities, stocks do not offer a fixed rate or return and entail a greater risk to principal.

The hypothetical performance and simulations shown are for illustrative purposes only and do not represent actual performance; they are not a reliable indicator for future results. The hypothetical performance results may benefit from hindsight, is based on historical data and does not reflect the impact that certain economic and market factors might have had on the decision-making process, if a client’s portfolio had actually been managed.



Attribution: Stefan Rondorf, CFA, AllianzGI Economics & Strategy Group

Specifics of the research: Begin with $100 invested in the Datastream US Total Market Index, then take whatever return you finish with and then add the next $100USD. For example, if the first year was a 5% return year, you now have $105+$100=$205 in your portfolio. The end return of 11.6% does not consider all the 100 USD injections themselves but all the compounded returns these injections have made. Also please note that the returns include dividends as we use the Total Return index version of this Datastream index.

It is also important to note that the return number used here is the internal rate of return which is more appropriate as compared to a constant annual growth rate (cagr) which would include the regular injections of the $100 each year and so is biased upwards.

The Datastream Total Market Index comprises more or less all listed stocks in the US (ex ADRs), reset quarterly, weighted by capitalization. In the analysis it is a proxy for the whole market. Below please find specifics on the index. It is not possible to invest directly in an index.



Past performance of the markets is no guarantee of future results. This is not an offer or solicitation for the purchase or sale of any financial instrument. It is presented only to provide information on investment strategies and opportunities.


A Word About Risk
: Equities have tended to be volatile, involve risk to principal and, unlike bonds, do not offer a fixed rate of return. Foreign markets may be more volatile, less liquid, less transparent and subject to less oversight, and values may fluctuate with currency exchange rates; these risks may be greater in emerging markets.
 
The material contains the current opinions of the author, which are subject to change without notice. Statements concerning financial market trends are based on current market conditions, which will fluctuate. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Forecasts and estimates have certain inherent limitations, and are not intended to be relied upon as advice or interpreted as a recommendation.

 

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