Timing the market usually refers to buying securities when the price is low and selling them when the price is high. Trying to time the market can be tempting because it may seem like you can make a lot of money, but it is not without risks.
Buy low, sell high. Although simple in theory, in reality it is very unlikely that you will be able to time the market successfully. Chances are you buy things that you think will increase, but it never happens. Then you sell it at a loss. This scenario is all too common, which is why you should try not to time the market.
Although you can try to time the market, in most cases it is better to avoid it. Fortunately, there are several alternatives instead. Depending on your goals, one of the alternatives may be a better choice.
Timing the market: This is why it is a bad investment strategy
Timing the market is difficult. Actually, that’s probably an understatement, since very few people can time the market consistently. In fact, even professionals who try to time the market usually fail. For example, a report from S&P Dow Jones Indices shows that over a 20-year period ending in 2023, less than 10 percent of actively managed U.S. stock funds managed to beat the index.
There is a lot of potential to lose money in market timing. Obviously, you will lose money if you have to sell stocks or other securities at a loss because the price does not rise.
But even buy-and-hold investors can lose money if they try to time the market. Charles Schwab ran a scenario comparing five different investors. It gave them $2,000 every year for 20 years. It was discovered how much money they would all eventually have:
- An investor with perfect market timing: $151,391
- An investor who immediately invested his money: $135,471
- An investor who has performed dollar-cost averaging: $134,856
- An investor with poor market timing: $121,171
- An investor who left his money in cash: $44,438
In the experiment, the investor with perfect market timing actually performed best. But the second best result came from the investor who invested his money immediately and paid no attention to market timing. And the second worst investor was the one with bad market timing.
This example illustrates why market timing is a bad investment strategy. The vast majority of investors who try to time the market fail. That means that after twenty years your portfolio will more likely look like the second worst outcome above. But if you immediately invest your money in a low-cost index fund, you’ll likely be among the best performing funds in the long run.
Top alternatives for market timing
Timing the market can be tempting, but for most investors it is not a viable long-term strategy. Fortunately, several alternatives can produce better results.
Varied portfolio
Diversifying your portfolio means holding a portfolio of different assets, such as stocks, bonds, real estate and cash. This approach has several benefits, including spreading your risk across multiple assets.
Furthermore, investing in different types of assets gives you exposure to different markets, which can have a negative correlation with each other. This helps protect you from volatility because you are not focusing on one type of investment. Diversifying your portfolio can help you achieve better results while reducing your long-term risk.
Dollar cost averaging
As we saw in the example above, dollar cost averaging doesn’t always produce the best results in the long run. However, it can be scary to invest all your money immediately. It can feel like you’re giving up control of your portfolio, and not all investors are comfortable with that.
That’s where dollar-cost averaging comes into play. Instead of investing all your money immediately, invest periodically, such as once a month. The idea behind this strategy is to avoid the possibility of accidentally investing your lump sum when the market is at the peak of the year. Instead, you get exposure to different market conditions, which will help you achieve better results overall. Again, it may not always be better than investing right away, but in most cases it is still better than trying to time the market.
Long term investing
If you want your portfolio to grow, investing for the long term is one of the most important things you need to do. A good way to understand why this is important is to look at this chart of the S&P 500. Looking at this chart, we can see that the broad stock index has had many ups and downs over the past 70 years. The S&P 500 is often used interchangeably with the general market. When someone asks “how the market did today,” they typically mean the S&P 500.
Even though the market has had many big declines during that time, it has always recovered and eventually moved higher than the previous high. By simply keeping your money in the market, you can benefit from this growth. Although the big drops can seem scary, history has shown that the market always recovers and then comes back stronger.
In short
A popular expression in personal finance communities is, “time in the market is better than timing the market.” Timing the market can be tempting, but for most investors it is not a viable long-term strategy. For most of us, combining a diversified portfolio with long-term investing is best. In addition, it is wise to consult a financial advisor who can help you set up a portfolio that is tailored to your situation.
— Bank interest Brian Baker contributed to an update to this story.
Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making any investment decision. In addition, investors are advised that the past performance of investment products does not guarantee future price increases.
