In her book Juggling Dynamite, money manager Danielle Park, points out that an investor who avoided the 10 worst days of the market would have posted returns of 5.9% and 59% in 2002 and 2003 compared to -24.2% and 26.4% for a buy-and-hold investor in the S&P 500. She says:
In fact, history shows that investors who avoid the big market downturns need only capture 30% of the next upmarket cycle in order to fare just as well as perpetually invested and therefore more risk-exposed buy-and-hold investors.
Numbers such as these make it very difficult to argue that there would not be lasting benefits were investors able to step out of markets and avoid the bulk of the ugly price corrections and the resulting losses.
There are two questions that average investors need to ask of any investment philosophy that promises more reward (for the same level of risk) or less risk (for the same level of reward) when compared to a stock index:
- Has it worked in the past? Is the after-tax return (adjusted for risk) better than simply buying and holding the index? Is there any reason to believe it will continue to work in the future?
- Can the average investor successfully follow the investment strategy?
Unfortunately, market timing fails both tests. I don’t know the track record of Ms. Park’s strategy for market timing compared to the S&P 500 (let alone a diversified portfolio) but we do have some evidence about how successful market timers are as a group. According to Mark Hulbert, who tracks market-timing newsletters, roughly 80% of newsletters under perform the market indexes. John Bogle, as you would expect, has a devastating opinion on market timing:
In 30 years in this business, I do not know anybody who has done it successfully and consistently, nor anybody who knows anybody who has done it successfully and consistently. Indeed, my impression is that trying to do market timing is likely, not only not to add value to your investment program, but to be counterproductive.
Even if you believe that market timing works, you have to decide if you’ll be good at it. By definition, market-beating strategies are hard to practise because if everyone can do it, they will have acted on it already and ironically, it won’t work anymore.
The choice for average investors is clear: buy-and-hold a diversified portfolio of low-cost funds and rebalance regularly. Let’s say that an unlucky investor with a 75% exposure to equities, invested a lump-sum just as the market was peaking in 2000. At the end of 2006, he would have earned an annualized return of 3.6% during one of the worst bear markets in history. The good news is that unlike the unlucky investor, we save and invest periodically, in bull and bear markets and our returns are likely to average about 6% even in a low-return environment.
