“Making money in the stock market is easy. Just find a stock, Buy it. When it goes up, sell it. If it doesn’t go up, then don’t buy it.”
– Attributed to Will Rogers
Most investors are comfortable with the “buy- and- hold” approach to investing. In other words, they ascribe to the theory that success in the long term means getting into the stock market and staying there. The alternative, the market timing approach, calls for an attempt to predict the future direction of the market, looking for tops and bottoms in price movements. In other words, a’ la the Will Rogers approach, they choose stocks that they believe are on an upward swing and hold them as long as they rise, making a decision to sell when they believe that prices are about to fall.
Most experts adhere to the former approach. After all, the classic study published by Ibbotson Associates, the Chicago research firm, revealed that if an investor had been able to put $1 in the stocks of S&P 500 in 1926 and keep it there, that meager investment would have grown to $1,114 by 1995 (including reinvested dividends).* But an investor who was out of the market during the 35 best months out of the 840 months in that time period would have seen that $1 grow to only $10.
Time to re-evaluate the traditional approach?
Of course, a lot has happened since 1995. A steep ride up, followed by a precipitous fall, followed by the current, somewhat improved market. Yet some forecasters see returns remaining weak for years, perhaps as long as ten years. As a result, some are predicting that the buy- and- hold strategy may not yield returns that will satisfy current investors.
But caution should be the watchword before an investor decides to adopt a market timing approach to investing. The continuing stream of research about market timing isn’t encouraging.
James K. Glassman, author of The Secret Code of the Superior Investor: How to Be a Long- Term Winner in a Short- Term World (Crown Business, 2002), is a strong voice in a chorus of voices echoing about market timing.
Timing a dangerous, he says- in rather stark terms- for two reasons: “First, you can’t do it. Second, the payoff for accurately timing the market isn’t worth the risk.’
Glassman quotes John C. Bogle, founder of the Vanguard Group, one of the two largest mutual fund organizations in the world, and considered one of the financial leaders of the 20th century, to support his statement: “After nearly fifty years in this business, I do not know of anybody, who has done it successfully. I do not even know anybody who knows anybody who has done it successfully and continuously.’
A look at some hypothetical investors
To support his second statement, Glassman turns to the research of Bryan Olson of the Centre for investment Research at Charles Schwab & Co. In Olson’s scenario each of four investors is given $2000 a year on December 31 for 20 years, starting in 1979. Every year A puts his money in stock of S&P 500 at the end of the month that has the lowest price of the year (a perfect market timer). B puts his money in the S&P stocks on December 31 and leaves it there. C purchases the S&P stocks at the end of the month that has highest price of the year (the poorest possible market timer). D who’s afraid of the stock market, buys Treasury bills.
Results after 20 years
A, the perfect market timer – $387,120
B, the buy-and-hold investor – $362,185
C, the poor market timer – $321,569
D, the T-bill investor – $76,558
What’s surprising, as Glassman points out, is that A, with perfect market timing sense, does only about 7% better than the investor who adheres to the buy-and-hold philosophy. On the other hand, the poor market timer did significantly worse, 11% less than the buy-and-sell investor. And the T-bill investor wasn’t even in the running.
In other words, Glassman says, “Being there” (in the stock market), simply taking advantage of opportunity when it came, was the most successful strategy.
New research
In July 2002, Dalbar, Inc., a leading financial services marketing research firm, updated its Quantitative Analysis of Investor Behavior. Dalbar reviewed investor returns from equity, fixed income and money market mutual funds from January 1984 through December 2002, examining cash flows into and out of funds.
Equity investors, Dalbar concludes, have continued to chase investment returns, to their detriment. The numbers show that investors tend to pour money into equity funds on market upswings and are quick to sell on downturns. As a result, they are left with fund returns lower than inflation.
For instance, the average equity investor held on to his or her fund shares an average of only 29.5 months and earned a small 2.57% annually, compared to an inflation rate of 3.14% and a 12.22% return that the stocks in the S&P 500 index averaged annually for the last 19 years. The fixed- income investor did slightly better, holding his or her shares 34.3 months and earning 4.245 annually, compared to the long –term government bond index of 11.70%. By comparison, T-bills registered a 5.5% annualized gain.
Taking a measured approach
Some commentators suggest that the Dalbar study could be somewhat skewed by its focus on fund flows. But, clearly, the results support the conclusion that investors should refrain from trying to chase performance and should, instead, zero in on specific financial goals, such as saving for college or retirement.