When investing, it is easy to be lured by false promises of beating the market, timing the market, and getting guaranteed returns. While these offers can be tempting, numerous studies prove that it is extremely difficult to time the market and make a profit.
This article breaks down marketing timing, one of the key reasons we use an evidence-based investing approach at Cambridge Partners.
Let’s bust one particular financial myth:
Myth: Buy low, sell high
Many of us have experienced a friend bragging about a share or stock they own. The story usually sounds like this: They invested when the share price was low, and it became a success story with the share price hitting a high. They sell their shares for a profit, and shortly afterwards, the company hit hard times, and the share price drops.
In investing, we call that ‘timing the market’.
Actively managed investment strategies often adopt this approach and are generally used by traders, speculators and active fund managers. It requires watching the market daily and staying tuned into the companies you are invested in and the current market environment. This approach is time-consuming, complex, and short-term focused for the average investor. Many academics and financial professionals believe it is challenging, if not impossible, to time the market consistently.
Why is it so hard to time the market?
- Markets are efficient: Financial market prices globally reflect the sentiment of millions of buyers and sellers, each with their views of the right price. The speed of information conveyed in earnings data and financial reports is immediately priced in. So it can be challenging to find inefficiencies that could result in a profit, and even harder to do it repeatedly.
- Basic maths: Buyers and sellers must agree on a price. If a buyer feels they can profit from buying a share in a company that has been mispriced, then the seller is going to be the loser on the other side. One winner plus one loser equals zero winners or losers. It is a zero-sum game.
- High costs: Research, trading, and premium prices contribute to high-cost factors of falling in love with an individual company. Active fund managers pay their staff big salaries and bonuses, and investors must carry that cost also.
- News: You may believe that your share in a company is solid and steadfast in today’s market environment. However, look at what a geo-political crisis, such as the war in Ukraine, can do to the energy sector and the long-lasting effects of the pandemic on the hospitality and tourism sectors.
The evidence against timing the market
Research (Morningstar, 2019) shows that actively managed funds have generally failed to survive and beat their benchmarks, especially over longer time horizons. Only 23% of all active funds surpassed the average of their passive rivals over the ten years that ended in June 2019.
Nobel Laureate William Sharpe conducted a study in 1975 called ‘Likely gains from market timing’ (Sharpe, 1975). The study looked at market timers against passive index funds tracking a benchmark. It concluded that an investor using a market timing strategy must be correct 74% of the time to beat the benchmark portfolio.
The ability to consistently beat the market over the long term is challenging. Successful fund managers that can capture returns year after year will generally charge high fees, plus performance fees, for their skills.
A wise person once said
“The reality is, it’s time in the market, not timing the market”, Bank of America Vice Chair Keith Banks (Banks, 2020).
By Jenaia Clarke, Financial Wellbeing Champion and Head of Marketing
8 August 2023
Back to basics: Starting with evidence. (2019, June 17 Accessed 7 August 2023). Retrieved from TEBI: https://www.evidenceinvestor.com/back-to-basics-1-5-starting-with-evidence/
Banks, K. (2020, Accessed 8 August, 2023). Vice Chairman of Bank of America. (S. B. CNBC, Interviewer)
Morningstar. (2019). Active funds vs. passive funds: Which fund types had increased success rates? Accessed 7 August 2023: https://www.morningstar.com/lp/active-passive-barometer.
Sharpe, W. F. (1975). Likely gains from market timing. Financial Analyst Journal, Volume 31, Issue 2, pp. 60-69.
Disclaimer: This article is general information and does not consider your financial situation or goals and does not constitute personalised advice. There are no warranties, expressed or implied, regarding the accuracy or completeness of any information included as part of this article.