There are many things that could affect the overall equity market and any individual stocks you may own—from economic trends like rising inflation to geopolitical events like a war in Europe. What is certain is that the market will always have its peaks and dips.
Knowing that market cycles exist can make it tempting for investors to attempt to buy and sell stocks based on the news or recent market movements in an attempt to maximize gains and avoid down periods. While simple in theory, the strategy known as market timing aims to move in and out of the market based on predicting when the market will shift.1
Missing Out on Market Moves
Although the idea of market timing can be alluring, it is also extremely difficult for most investors to carry out in practice, since no one can predict the future. In fact, those who try to time the market may actually underperform investors who simply buy and hold stocks.2
One reason is the tendency of the market to experience big upswings and downswings on adjacent days during periods of market volatility. That means an investor who sells and moves to cash after a substantial down day for the market may miss a subsequent period of gains. Also, many investors let emotions dictate their actions, leading them to buy stocks when the market has already gained in value, only to sell when the market has declined, generating sluggish returns.
Moreover, even with sophisticated tools to analyze the factors affecting stock prices, it is very difficult to forecast future stock market movements. For market timing to work, investors have to be right twice—knowing both the optimal time to get out of the market and the best time to get back in.
Missing out on just some days in a market cycle can drag down returns considerably. The S&P 500 generated an annualized return of 9.6% between 1990 to 2018 for investors who remained invested during that entire period. Investors who missed just the 15 best days during that period only saw returns of 3.6%, and investors who missed the best 90 days actually suffered an annualized loss of 3.5%.3
Market Timing Can Carry Costs
Along with possibly missing out on market gains, market timing can have other penalties. The transaction costs from buying and selling stocks can add up and drag down overall returns over time. In addition, investors who do sell stocks for a gain may trigger capital gains taxes, again reducing their overall profit.3
Creating and staying with a financial strategy can help you avoid making rash moves in response to what’s happening in the market. A Financial Advisor can help you tailor a framework that’s set against your long-term goals and considers key aspects of your financial life, from your age and aspirations to current market opportunities. While market conditions may vary, a personalized, adaptable wealth strategy centered around your life goals should remain a constant as you build your wealth and plan for your future.