I love vacations – sitting on a beach, reading a book, and acting like I’m watching my kids. What I absolutely do not love, however, is booking a vacation. It is probably due to some karmic balance that vacation planning is so stressful, but two of my absolute least favorite things are booking hotels and flights. If I check on airline tickets today, they might be $150 per ticket. Tomorrow? $202. What could have possibly changed in 24 hours that has bumped up the ticket prices so much? And even more maddening, if I book that flight at $202, I know when I check it again they will be down to $130. If I pass on $202 however, then it must, of course, go to $290.
We encounter that same stress when investing. The fear of making a mistake can paralyze an investor and significantly impact overall investment returns. Trying to predict when the market might be up or down is like trying to guess the best time to buy airline tickets. Maybe you thought about selling stocks yesterday, but the market was down so you decided to wait. Today it is down even more and now, in a panic, you sell at a worse price just to avoid the potential of a greater loss tomorrow. This does not sound like a pleasant investment experience, or even one that has much direction.
Why, then, do so many people try to time the market? Nobel laureate Robert Merton, speaking at an analyst conference, provided some insight. Suppose an investor put $1,000 in 30 day US Treasuries on January 1st, 1927. On December 31st, 1978, fifty-two years later, they would have had $3,600. Let’s say that same person decided to instead invest that $1,000 in the NYSE stock index. Over that same period, they would have ended with $67,500. But what if they knew perfectly what would happen and had a 100% success rate in timing the market between the stock index and US Treasuries. How much would that person have? Five hundred thousand dollars? A million? How about $5.26 billion. So, sure, market timing sounds like it could do wonders for your investments. The problem, of course, is that you have to perfectly time those transactions and never make a mistake.
So what if you aren’t a perfect market prognosticator? Research from Bill Sharpe, winner of the 1990 Nobel Prize in economics, shows that you need to be right 70-80% of the time just to break even – before factoring in transaction costs or tax consequences. Think about that – if you were able to correctly predict what the market would do 200 out of the 250 trading days each year, you would likely do worse after accounting for trade costs than somebody who just bought a market index and forgot about it.
Watching investment commentary or reading most business journals, you will hear an endless number of “experts” telling you to buy this, then sell that. You will read predictions that the market is going to drop 15% percent this year and you need to Get Out NOW! But, in the next issue (and often even in the same issue), you will hear that the market is primed to reach new highs. At WealthPoint, we keep track of what is happening in the market. I read reports on current employment trends, read through earnings reports, looked at the 10 year Shiller P/E numbers, and I can tell you the current yield on the US 10 year Treasury. Does that mean I know what will happen tomorrow?
No. And neither does anybody else.