indicatorMarkets

Does market timing work?

By ATB Financial 28 May 2019 2 min read

A popular chart created by JP Morgan looks at what realized annualized returns would have been like if the 10 best trading days in US stocks had been missed, as represented by the S&P 500. The underlying message of the chart is patience. That it is better to stay invested, even when investors see their account values drop and they become tempted to move to cash.

 

Missing the best days

From the start of 1980 to the end of 2018, the S&P 500 experienced an annualized return of 11.33%. However, this didn’t come without trials and tribulations, because throughout this time period there were a number of declines of 20% or more. Using the same data, what would performance have been like if we had missed the best trading days for US stocks?

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Annualized return chart missing best days


Overall, not great. By missing just the top 10 best days, the annualized return dropped from 11.3% to 9.26%. By expanding the analysis to missing out on the top 50 best trading days, the annualized return was cut in half.

 

Missing the worst days

On the flip side of the JP Morgan chart, how would missing an increasing number of the worst days in the market affect an investor’s potential return? As you can see in the chart below, the investor would have done much better than being fully invested the whole time.

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Annualized return chart missing worst days


Does market timing work?

This story, however, is not about missing the best or the worst days, because no one has a crystal ball. Missing the best and worst days in the market implies one has the ability to market time. This isn’t realistic, as no one can perfectly time the markets.

Bear markets are especially difficult to time, for both amateur investors and seasoned professionals. In addition to timing when to get out of the markets before the worst days hit, the added challenge is timing when to get back in.

The fear that is instilled by these kinds of market declines can make getting back into the market challenging. It is common for investors to wait on the sidelines until they feel safe again, usually once markets have moved back up, before wading back in. This is often too late, because the best and worst trading days often happen close together. Since 1980, 41 of the 50 best trading days happened in the same years as the worst bear markets.

By staying out of, or even trying to time the market, investors might miss the worst days, but they could also miss the best trading days. This kind of behavior would leave returns on the table and sabotage the ability for investments to compound over time.

What should the well-informed investor do about this? Unless you do have a crystal ball, the best thing to do is stay invested. Take the good days with the bad, allow time to be your ally and compound your investment returns. Create an investment plan and build a portfolio that helps buffer on the downside, so you remain comfortable while navigating the often-choppy markets. 

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