Why Market Timing Doesn't Pay
Jan 27, 2016
Allianz Global Investors has come out with some compelling research on why trying to time the market just doesn’t work. One of the main reasons is that you must time it correctly twice. The first step is to time the market and sell before the downturn, then you must accurately time the market again to buy at the bottom. Not only is this extremely difficult, or downright impossible, it also carries substantial risk as according to Allianz’s research: missing the three best trading days of the year drastically reduces your return. These days typically happen following a large decline in the market, right when investors panic and sell. Missing these sharp relief rallies is a risk of market timing that you can’t afford to make.
Below is information on the four cases that Allianz looked at. All of the information is based on the Datastream US Total Market Total Return Index from 1973 through to the end of 2014.
Case 1: Investing $100 on Jan 1 of each year and adding $100 on Jan 1 every year from 1973 to 2014. The result? Total Return = $52,251 with an Internal Rate of Return of 7.41%. This could be considered the passive investing strategy, add to the market over time and ignore the noise.
Case 2: Investing $100 per year and if you happened to purchase the index at the lowest point of the year every year from 1973 to 2014. While you would expect being able to buy at the bottom every year to have substantial returns, the results show differently. Total Return = $54,355 with an Internal Rate of Return of 7.68%. This is barely better than the passive strategy and you would need a crystal ball in order to actually achieve it.
Case 3: Investing $100 per year on the worst day of the year, or the highest point the index reached during the year. This represents what would happen if you bought high every year from 1973 to 2014. Again the results are surprising, Total Return = $51,940 with an Internal Rate of Return of 7.06%. This again reinforces that even if you picked the worst time to invest, staying invested generated you a respectable return.
Case 4: The risk of market timing. This time it assumes you invest $100 per year on Jan 1, just like Case 1. The difference is that you missed out on the 3 best days of the year. This represents what happens if you try to time the market incorrectly and miss the big relief rallies. The Total Return = $2,953 with an Internal Rate of Return of -2.14%.
So what does this information show us? The difference between buying on a set date, buying on the best day of the year, and buying on the worst day of the year produce very similar returns over a long period. The biggest risk? Missing the 3 best trading days of the year, and this is the risk that happens if you try to time the market and miss the big relief rallies that follow panic selling.
All information was taken from Allianz Global Investors and the original infographic can be located at: