At Premier, our wealth advisors often field questions about market timing: Should I act on that hot stock tip I saw on TV this morning? What about the advice of the latest investment guru in the financial media? Is that financial pundit's approach right for me?
Though we understand why market timing might be appealing — after all, the financial media and many investment professionals alike push an active investment approach relentlessly — the reality is that years of quantitative
research and real-world evidence point to one undeniable fact: Market timing isn't an effective wealth management strategy.
It may be "glamorous," but attempting to beat the market represents nothing more than a way to introduce chaos into your investment planning... not something the rational investor wants to do.
Here's why you should avoid market timing.
Personal Wealth Management and Market Timing
There's a reason why great economic thinkers such as Nobel Prize winners Eugene Fama and Robert Merton, who described market timing as "a fool's errand," don't support an active investing approach. In a nutshell, being successful at stock picking means you have to be an accurate fortune teller, with the ability to know beforehand exactly when a stock will hit a low point (to buy) and exactly when a stock will hit a peak (to sell.)
While it's a great idea in theory, real-world evidence doesn't support this method's efficacy. Long-term studies indicate that, overall, returns gained by market timing are eaten up by the many costs, fees, and expenses associated with this type of investment strategy. Plus, there's the simple fact that if the principles behind market timing held up, every investor would be making a killing. That's simply not happening.
Market timing comes along with a host of costly issues, such as:
- Hidden fees and costs
- Lower returns for higher risk
- Greater exposure to unnecessary risk
One counterpoint that some investment professionals may argue is that you can base stock picking choices on past marketing performance. Using this approach, you could purchase data and exhaustively research past trends... the problem is that there is no guarantee that history will repeat itself. Industries, sectors, and companies — and their stocks — are at the mercy of a host of unexpected events, none of which can be foretold with any accuracy.
Why Do Investment Professionals Advocate Stock Picking?
Given that the active investment approach isn't as efficient, why do so many investment professionals continue to recommend it to their clients? For some, the answer may lie in the higher costs and fees associated with market timing. An active approach leads to more selling and more buying, which leads to higher commissions for non-fiduciary investment professionals.
Plus, active investing just seems more "exciting" than the passive approach. As the financial media's job is to get higher ratings (and draw more advertisers), it's easy to understand why the self-appointed financial gurus and pundits would focus on "hot" tips of the day, rather than a long-term, passive investment strategy. In the end, the active approach tends to be based on emotional decisions, and that makes for better news than a calm, steady, stay-the-course approach that's associated with passive investing.
Being successful at market timing depends on luck... not skill. If you're confident in your ability to accurately tell the future and if you're sure that you're going to have really good luck every time, then the active approach might be for you. But if you'd rather reduce unnecessary exposure to risk, reduce the amount you pay in costs and fees, and not introduce chaos into your portfolio, then avoid market timing.