Buy low, sell high. That’s the essence of successful market timing.
But what if the timing of trades makes almost no difference in the long run?
As the end of the year draws closer, and as the major market indices bounce around all-time highs, there are likely many investors questioning the wisdom of buying shares of stocks or stock mutual funds now.
Isn’t it better to sell, not buy, at the end of the year? How smart is it to buy stocks at record highs? A new study out this year can help answer these questions.
The study, as reported by Kiplinger, is by Dan Wiener, editor of The Independent Adviser for Vanguard Investors, and he compares the records of two hypothetical investors over the past 30 years.
Each began investing $1,000 in the S&P 500 Index at the end of 1983. Over the next 30 years, each investor put $1,000 annually into the S&P 500. However, in those subsequent years, the first investor bought on the last trading day of the year while the second investor bought at the S&P’s highest point each year.
In summary, investor one used an annual dollar-cost averaging strategy, while investor two had the worst possible timing each year.
What would you guess to be the results? You might be surprised to know that, at the end of 30 years, investor one had achieved an annualized return of 9.9%, while investor two earned an annualized return of 9.5%. That’s a small difference in return of just 0.4%.
Time in the Market Beats Timing the Market
You may have also seen studies that reveal how a large portion of long-term returns consists of just a handful of days during each calendar year, averaged in over long periods of time, such as 10 years or more.
History reveals that the largest gains often come soon after the steepest declines. For example, if you consistently miss five of the best days in every calendar year, your long-term returns can be reduced by more than 2% (e.g. 9% return reduced to 7% return).
To be fair, a fortunate market timer could significantly increase their long-term returns if they miss the worst five days each year. Therefore, the most likely way to really beat the market over time is to be invested for some or all of those best days and to miss some or all of the days when prices fall the most.
But who knows when the big gains or losses will occur? Are there any money managers who have successfully timed the market?
In his book, Common Sense on Mutual Funds, John Bogle, the founder of Vanguard Investments, wrote this on his knowledge of market timing: “I do not know of anybody who has done it successfully and consistently. I don’t even know of anybody who knows of anybody who has done it successfully and consistently.”
As the wise saying goes, time in the market most often beats timing the market.
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