| 31 August 2009
Nobel Laureate William Sharpe estimates that a market timer needs to be right 82% of the time in order to equal the returns of a buy-and-hold investor. Another view of this is from a study we follow every year: In its annual update to the study, Quantitative Analysis of Investor Behavior (QAIB), DALBAR found that the S&P 500 has returned 8.35% annually over the last 20 years, ending in 2008. The average equity investor, however, earned just 1.87% - less than the 2.89% inflation rate over that time frame. The study points out that market timing basically stole the returns for the average investor.
I can continue to cite study after study that shows market timing just does not work. Part of the reason is because timing is based on emotions, usually panic or euphoria, and in the short-run emotions can be false indicators. Market timing fits nicely in a society that is more in tune with instant gratification than patience and discipline but I would argue it is a false god (I feel like a Roman history major right now).
Market timing is less important than time in the market. Yet I would be foolish to argue that even our firm does not make changes to portfolios, and that is where systematic rebalancing comes in. Rebalancing, by definition, is not reallocation. We do not re-think our overall asset allocation; we simply move money around to get back to the original targets we set with a client. For example, we have some clients who invested money over the past year (bravely I might add) who are now overweight in equities due to the last six months of market gains. I am now calling them and recommending we trim a little off their equities to buy bonds, getting them back into a balanced portfolio that is based on their goals and tolerance for risk.
If you think about rebalancing, you will always be selling high and buying low. Notice I do not say that we are selling completely out of stocks. I do not know where the market will be a month from now much less a year from now so I always want to maintain stock exposure. The fallacy of market timing is that your life or goals start and stop on any one day depending on your mood or that day's market. Just look at how you might have felt in February of this year, and look how you feel now; you cannot win if you are not participating in the game.
My experience with people that want to time the market is that they largely end up sitting on the sidelines waiting; unsure when they should get in (this applies to professionals as well as retail investors). And that is frustrating for them; the last six months has been frustrating for many pros. To me, market timing is similar to changing lanes while driving just to get around one car, only to be sitting right next to that car at the next stoplight. Very frustrating, and it gets us no closer to our final destination.