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Market Timing – Time in the Market vs. Timing the Market

Market timing refers to trying to predict future market movement to buy or sell at the best price. Here we’ll look at why it doesn’t work, and why you should stay the course and go ahead and invest as soon as possible.

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Introduction – What Is Market Timing?

Market timing describes the speculative strategy of trying to time one’s trades based on predictions about future market movement. While this could apply to selling, we’re usually talking about the buy side, where the investor is deciding when to enter a position.

Market timers believe they can outsmart the market and buy at a low point, for example, to later sell at a high point (buy low, sell high), instead of possibly buying at a high point by accident. Market timers may believe a particular market is overvalued and will delay their trades until they think the market has “cooled off.”

Proponents of market timing will claim that their forecasting of price movement will lead to superior outcomes in the form of higher returns. Timing the market is obviously the lifeblood of the day trader, but oftentimes long term investors also sit on cash while waiting for a market dip, which is market timing as well. That is, even the long-term buy-and-hold investor buying passive index funds can still succumb to recency bias.

Time In the Market vs. Timing the Market

So market timers try to get the best price by predicting market behavior so that they can buy low and sell high. Sounds great, right? What’s wrong with that?

Unfortunately, just like with stock picking versus passive indexing, the evidence overwhelmingly suggests that successfully timing the market is all but impossible, for the simple reason that market movement is essentially random and unpredictable, as all available information is already priced in. All crystal balls are cloudy, and one cannot expect to accurately and consistently time the market. In fact, the practice is usually more harmful than helpful.

As usual, psychology and emotions play a huge role here. Investors may feel that their investments are “due for a correction” after flying high, or that they’re due for a comeback after a recent drop, but nothing says the investment can’t continue going up or down respectively. The first investor may shave off some profits to lock in their gains, but their original thesis about the future growth of the investment hasn’t changed, so this is irrational behavior. Alternatively, that same investor may believe the recent run up means the stock is on a hot streak, so they buy more; this is equally irrational. On the other side of the coin, the same can be said about panic selling in a crash. These irrational, emotion-based trades are more likely to hurt the investor’s long term total return. Fear and overconfidence can be massively damaging to one’s portfolio.

Studies suggest that “time in the market” is the way to go. That is, as I’ve said before, invest early, hold for the long term, and ignore the short term noise. Stay the course, as Jack Bogle said. In doing so, we’re relying on the simple premise that the market tends to go up more than it goes down, so we don’t need to try to time its movement. As long as the fundamental reasons for investing in the first place haven’t changed, the “time in the market” investor simply keeps buying regularly, regardless of market sentiment or valuations.

Moreover, the market spends a non-trivial amount of time at all time highs, which are usually not followed by major dips, so there’s no logical reason to sit on cash in fear of a crash just because the market is looking good. In doing so, market timers usually simply miss out on those gains on the way up. The common saying now is that “time in the market beats timing the market.”

This concept is very closely related to the idea of dollar cost averaging vs. lump sum investing. The former describes spreading out a sum of cash over regular intervals. The latter describes investing the total sum all at once as soon as it’s available, which is demonstrably superior on average. In this sense, dollar cost averaging – or DCA for short – is like market timing, in that the DCA investor usually fears an impending crash and wrongly believes that sitting on investable cash and averaging that money into the market is safer and will provide a superior outcome. The lump sum investor ignores their feelings about the short-term future of the market.

While we have loads of evidence illustrating the futility of active management and market timing, their allure persists, largely due to behavioral biases. Ironically, the market timer is likely to continue trying to time the market due to hindsight bias, for example, which means humans tend to remember their past predictions as more accurate than they really were. Loss aversion plays a huge role here too – the principle that people are more sensitive to losses than to gains, suggesting that we tend to do more to avoid losses than to acquire gains. Market timers may realize they can’t beat the market, but they still think they can avoid losses by sitting on the sidelines waiting for a crash that may never come.

The Costs of Market Timing

There are several important explicit and implicit costs of trying to time the market that illustrate its suboptimality as an investing strategy on average.

The first is fees. Granted, many modern brokers are adopting a fee-free trading model, but if you happen to be with one that still charges commissions on trades, you’re incurring one every time you time the market or dollar-cost-average in, as opposed to a single one up front on a single lump sum buy order. You’re also taking on the bid-ask spread with each new trade as well. Tiny basis points add up over the long term. This cost is exacerbated in a taxable environment because you may be creating taxable events with your trades.

An implicit cost of market timing is your time. If you’re trying to predict market movement to buy low and sell high, any extra analysis and subsequent trading you have to do is an implicit opportunity cost where you could have been doing something else. If you spend 1 hour per week charting and placing buy orders, for example, that’s 52 hours per year spent on something that is very likely providing no benefit and is actually hurting your total return over the long term.

The most significant cost that I briefly mentioned earlier is missing out on market gains while sitting on cash, which intrinsically makes the investor’s asset allocation more conservative. This is again the main reason why lump sum investing beats dollar cost averaging on average, but the point is even more important in this context, as the market timer may be sitting on cash for months or even years in anticipation of a crash.

This is the most significant cost for a reason that many new investors don’t realize – that the stock market’s gains for any given year come from just a handful of days of stellar performance. The graph below from Schwab shows how missing out on just the 10 best days for the S&P 500 from 2001 to 2020 cut your total return in half, and the results go down from there:

market timing graph
market timing data table


In investigating the purported merits of market timing, we find yet another example illustrating how passive index investing beats active management on average. Trying to time the market is usually more harmful than helpful, and missing out on just a handful of days of market gains can have huge ramifications in the form of lower returns.

As always, pick an asset allocation based on your personal risk tolerance and time horizon, establish an emergency fund, invest early and often in index funds as soon as money becomes available (don’t DCA), diversify broadly across asset classes and risk factors, rebalance regularly, stay the course, and ignore the short-term noise.

Interested in more Lazy Portfolios? See the full list here.

Disclaimer:  While I love diving into investing-related data and playing around with backtests, I am in no way a certified expert. I have no formal financial education. I am not a financial advisor, portfolio manager, or accountant. This is not financial advice, investing advice, or tax advice. The information on this website is for informational and recreational purposes only. Investment products discussed (ETFs, mutual funds, etc.) are for illustrative purposes only. It is not a recommendation to buy, sell, or otherwise transact in any of the products mentioned. Do your own due diligence. Past performance does not guarantee future returns. Read my lengthier disclaimer here.

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