Monday, March 10, 2008
Thoughts on Market Timing
I often read in the PF blogosphere or personal finance websites: "It's impossible to time the market, so you shouldn't try". This is a gross distortion of what the data show. The data show that mutual fund investors lose from market timing. The biggest fund inflows tend to come towards peaks in the market and the biggest outflows towards troughs in the market. Alpha - risk-adjusted excess returns are a zero sum game and if some class of investors is losing another must be gaining. The gainers are going to be companies that issue and buy back stock, hedge funds, and sophisticated individuals. Research shows that companies gain from market timing. Obviously some hedge funds too. But if we know that companies can market time, why can't individuals? They can, but most individual investors lose from market timing. Mutual fund managers will try to discourage you from market timing because they hate having to invest money according to their mandate when prices are high and give it back when prices are low. So the mainstream financial industry has a vested interest in getting you to buy and hold.
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3 comments:
Hi moom,
I've always thought mutual funds promote their products to retail investors following a period of excess returns. This is one of the reasons individual investors are sucked in, hoping past performance will be repeated?
While it may be impossible to time markets they can improve their odds of success considerably by using moving average cross-overs which have worked over a period of at least a decade.
Investing outside their own country also leads individuals to make mistakes such that even when the market moves favourably, the returns are significantly diminished due to currency fluctuations.
Applying simple ideas can greatly improve market timing.
I deliberately got into mutual fund investments during a down time in the market, partially because it also just happened to be the first time in my life I had enough extra cash to invest! I felt like it was a success-- of course part of the reason was that the down time in question was 2000/2001 so I've had some time for returns to add up...
Liggerpig - that's a paradox - high past returns are used to attract investors but they don't want you to buy and sell the fund - often there are penalties for early withdrawal or limits on the number of switches you can make etc. It's certainly possible to improve returns by timing. Nailing the absolute bottom is going to be very hard as indicators can always fail. So dramatically going in and out of the market in one fell swoop is probably not a good idea.
Madame X - good for you! I started in 1997 when I first had any money to invest. Lost a lot in 2001-2003...
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