During the first quarter of 2018, the stock market reminded us once again that it can and does go down from time to time. Unfortunately, in practice the ability to accurately predict when corrections may occur (and act on them), better known as “market timing,” is extremely difficult and potentially very costly for both professional and retail investors.
Some of the most successful investors have shared their views on market timing:
“I have never known anyone who could consistently time the market. And in fact I’ve never known anyone who knows anyone, who was able to consistently time the market.” Jack Bogle
“The only value of stock forecasters is to make fortune-tellers look good.” Warren Buffett
“Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.” Peter Lynch
As these investors suggest, timing the markets successfully and consistently is virtually impossible. Furthermore, empirical evidence illustrates that market timing has negative implications for long-term investment performance. Many academic studies have analyzed this topic by comparing the time-weighted and dollar-weighted returns of investment funds. Time-weighted returns measure a funds’ actual performance, whereas the dollar-weighted returns measure the performance received by the investors. On average, investors underperformed the time-weighted returns of their investment funds by roughly 1.5%. That underperformance, or “behavioral gap” as it is often referred to, reflects investors failed attempts to time the market by investing or redeeming capital at the wrong times. This is confirmed by studies that show the largest equity inflows have occurred at the tops of markets and the largest outflows at the bottoms – the epitome of poor market timing.