Don’t Try to Time the Stock Market
Keeping on the right investing path means you must not try to time the stock market. In other words, don’t sell when you think the market is going to fall, and don’t wait around to buy until you think the market is done falling. If you do, you will almost be guaranteed to underperform the market. Here’s why…
First of all, everyone thinks they can time the stock market, but the fact is that no one can. While many “experts” have strong opinions about the future, the actual market is made up of so much complex information and unknown future events that no one knows what is going to happen next. Also, no one knows how investors will act to what new information comes out. Sometimes good news causes bad reactions and bad news causes good reactions.
Another reason that you can’t get ahead timing the markets is because overvalued markets often continue for years. For example, back in the mid 1990s many popular investors called the market overvalued and told their clients to sell. For those investors that sold, they missed out on the biggest and quickest stock market run in history.
And when markets are falling and investors are scared, many people want to sit on the sidelines and wait for the market to hit bottom before they invest again. That sounds like a good idea, but it could cost you a lot. In fact, in most market bottoms, if you miss the first few weeks of the rally, you will often miss out on months or even years’ worth of gains. Further complicating this, is that psychologically, its very difficult to get back into the market after it has gone up so much. This can cause further hesitation and cause even more underperformance.
Another problem with timing the market is that the consensus is almost always wrong. As things move along smoothly in the market, gradually, the majority of investors start believing that good things will continue. They become complacent and over confident. Bad things happen when there is a strong consensus, as some unforeseen economic data or business cycle can then cause a big change in the markets. The reason timing the market is dangerous is because investors who try it are most confident at the worst times. For example, when the market has been rising for years, investors get quite confident that the market will keep rising and so they buy stocks instead of selling before the next downturn. Similarily, when the market has been falling for months, investors don’t feel confident enough to buy stocks, even though it is usually the best time to buy.
The final effect that we believe makes timing difficult is the effect of investor confidence. During good times investors get very confident and it makes them feel smart. The more confidence in the markets the higher they will go. The higher and faster they climb, the bigger the next fall. Therefore, timing the market would mean buying when you are confident in the market and during confident times, the falls are always bigger, faster and harder.