A look at whether timing the market can work
This week’s Investing Compass episode looks at the hard data behind whether timing the market can work
Time in the market? Timing the market? Going against the herd? Investing success requires a bit of thought to achieve your goals.
Everyone always says that timing the market doesn’t work. It has been repeated ad nauseum by many investment professionals, including us. Is it actually true? The only way to find out is looking at the hard data behind it, and what strategy has worked well for investors to build wealth.
This week’s episode goes through why valuations matter to the returns that you get, how buy and hold strategies have worked out for investors.
Listen to the full episode below. Alternatively, read the full article here.
Listen on:
Get Morningstar’s insights in your inbox each morning. Sign-up for our email newsletters.
You can find the transcript to the episode below.
Shani Jayamanne: Welcome to another episode of Investing Compass. Before we begin, a quick note that the information contained in this podcast is general in nature. It does not take into consideration your personal situation, circumstances, or needs.
Mark LaMonica: So, Shani, I've never been so happy to start a recording of a podcast because before this happened, Will and I had to sit here and watch you show us the itinerary for your trip.
Jayamanne: I'm a little bit excited about my holiday. Can you blame me?
LaMonica: You're allowed to be excited about your holiday, but planning every minute of a four-week trip seems a little bit strange.
Jayamanne: I just don't want to think about anything when I go over there. I want everything just to be there for me and not have to think. I'll get out of bed, just follow the itinerary, go to all the lunches and dinners I've booked.
LaMonica: Yeah, and then Will and I started pointing out some obvious mistakes on this thing.
Jayamanne: It wasn't my mistakes, though.
LaMonica: And you just glossed over that. Like, you're going to Athens, but the little pin, and yes, there are pins on a map of all the places you're going, the pin was in Athens, Georgia, in the US.
Jayamanne: Well, that's a fault of AI. It's not me. So…
LaMonica: AI apparently assumed that people would rather go to Athens, Georgia…
Jayamanne: Georgia than Athens…
LaMonica: Than Athens, Greece. Athens, Georgia is where the University of Georgia is located, and they're a big rival to Alabama.
Jayamanne: Oh, roll tide.
LaMonica: Roll tide. All right. Let's do this.
Jayamanne: Okay.
LaMonica: So, we're going to talk a little bit about, I guess, human nature and some investing maxims that we hear all the time. And we do, as humans, like to boil down complicated concepts into maxims that then we just use to justify the decisions we make, right? It's like when somebody goes out and spends a bunch of money they don't have, they say YOLO.
Jayamanne: I don't think anyone says YOLO anymore, Mark, but continue.
LaMonica: Okay, people used to say that. And the advantage, of course, is that you don't have to think. Like, you don't have to think about the money you spent if you, whenever people said YOLO, said it from an investing standpoint, you don't have to think about what you're doing, you just use this maxim. And of course, the disadvantage is you don't have to think.
Jayamanne: This is very profound, but where are you going with this?
LaMonica: Yeah, deep thoughts on Investing Compass. But we're going to explore one of those little sayings that we hear all the time, and that is time in the market beats timing the market.
Jayamanne: And this saying is pretty self-explanatory. It means that instead of worrying about it, now is a good time to invest, you should just invest because ultimately the longer you're in the market, the better the outcome.
LaMonica: And history would suggest that this is the right approach. And I'll use some data from the US, but Australia follows the same pattern. Between 1926 and 2019, the US market had positive returns for the year 73% of the time. And that's pretty good. On a monthly basis, the market was up over that time period 65% of the time. And on a daily basis, the market goes up 54% of the time.
Jayamanne: And the fact that the percentage declines as we go into shorter periods of time tells you something. There are outlier positive returns on certain days that make the monthly return positive more of the time than the daily return and the yearly return positive more than the monthly return. You don't want to miss those days.
LaMonica: And because Shani loves data, we do have some more data for you. Over the last 30 years, if you miss the S&P 500's 10 best days, your return would be cut in half. If you miss the best 30 days, remember 30 days over 30 years, your return would be 83% lower.
Jayamanne: And that is why timing the market is an issue. Not being invested means missing most of those days. And 78% of the best days occurred in a bear market.
LaMonica: All right. So, it kind of seems like case closed. You can – maybe we can just finish the recording of the podcast. You can fix all the errors in your trip planning document. And we can go to the pub.
Jayamanne: Well, before we started this podcast, Mark was like, I woke up this morning and all I could think about was God I want to drink. So maybe you want to pack up and leave.
LaMonica: I definitely do. But unfortunately, I have a meeting till 5:30 tonight. But anyway, we will get back into this because there actually is more to this podcast. And I'm going to quote Buffett. So, anyone playing the Buffett drinking game can have that drink that I want so badly.
Jayamanne: Lucky for them.
LaMonica: Exactly. And this quote is a baseball quote. But I think even cricket fans like Shani get the general point. So, Buffett said, the trick to investing is just to sit there and watch pitch after pitch go by and wait for the right one in your sweet spot. And if people are yelling, "Swing, you Bum!", you just ignore them. So, what he's saying is that you need to wait for the right opportunity and not just mindlessly plow money into the market.
Jayamanne: That's a very test cricket quote, Mark.
LaMonica: Well, it's the same thing, right? With you just sit there and what do you call it, block the balls, block the balls. And then…
Jayamanne: And then this quote seemingly contradicts the motto that time in the market beats timing the market. And there is, of course, data that backs this up. Morningstar recently looked back at our fair value estimates to determine what impact they had on returns. We used our US coverage list, which includes almost 700 companies and explored data over the 21-year period starting in 2002.
LaMonica: And we aggregated the individual fair value estimates for each share. And we weighted them by the market capitalization, which is of course how major indexes like the S&P 500 and the ASX 200 are constructed. So, this provides a fair value estimate for the US market, or at least the portion that we cover, but it is 700 shares. So, comparing the aggregated fair value estimates and prices allows us to determine if the market is overvalued, undervalued, or fairly valued.
Jayamanne: And what we found is that when the market was deemed to be undervalued, the outperformance for the next three years was 0.76% a year. And this may seem like not much, but over the long run, it makes a big difference.
LaMonica: Okay, so what do we do as investors? We've got Buffett telling us not to swing at every pitch. We've got Morningstar data showing us that buying when markets are undervalued leads to outperformance. And we've got that adage that time in the market matters more than timing the market.
Jayamanne: Well, here is where we need to talk about the definition of market timing. On one extreme, market timing would be moving your portfolio around substantially in relation to where you believe the market is going over the short term. For simplicity's sake, let's say that you hold two assets, cash and shares. If you think the share market is attractive, you would be 100% invested. If you think it isn't, you would move 100% to cash.
LaMonica: And are there actually people that do this? Well, maybe somebody does, but I'm guessing it isn't a whole lot of people, especially hopefully people listening to this podcast. A lesser form of market timing is changing around allocations based on market conditions. For instance, your long-term asset allocation may be 90% shares, 10% defensive assets. But you think the market doesn't look good for whatever reason. So that could be scary newspaper headlines. It's fallen significantly. Or you think the valuation is too high and you move to 70% shares and 30% defensive assets. My guess is that most people do this when they're driven by emotions. They get really scared because the market drops a lot, and they sell some of their share portfolio.
Jayamanne: And finally, market timing is simply making small tactical adjustments to a portfolio for whatever reason. But we can use valuation as an example. In this case, instead of 10% cash, maybe you build up to 15% cash.
LaMonica: And I think we need to judge all of these differently. The first extreme example is a bad idea. That is taking an extreme bet on the direction of markets over the short term. The second example is also almost always a bad idea. Changing your portfolio substantially based on real or perceived views of the market doesn't lead to good outcomes. And it's a bad idea because you have to be right. And if you keep doing this over and over again, chances are you'll be wrong more than you're right. It is especially a bad idea if you were doing this because the market has dropped, and you were scared. Being scared is normal, but selling low is not the way to achieve your investing goals. Try and resist this urge.
Jayamanne: And that brings us to our last example. And I'm curious on your take on this, Mark, making tactical asset allocation changes that are relatively minor in the face of market conditions.
LaMonica: Okay, so my guess is you're sort of setting me up with that because I did do this, and I talked about it on the podcast. So, you're ready for all of my justification, Shani. All right. I want to make a couple of points first just to frame what I did. At no point did I sell anything to build up cash. I simply built up some cash and turned off dividend reinvestment. And I did that just by new contributions into my portfolio. And this definitely is market timing. But my main justification was that I made the decision in the context of my goals where strong market returns had lowered my required rate of return. And the vast majority of my wealth was still in the share market. The build-up in cash was relatively small. And I was still investing monthly into super, which is heavily weighted towards shares.
Jayamanne: So, I think the real question here is would you do it again if you could do it over?
LaMonica: Okay. Well, there's two different ways of looking at this. So, I was very worried about valuation levels and the behavior of investors, which to me looked like bubble behavior. Now, in retrospect, I was wrong. The market did drop significantly during 2022, and especially in the US and especially for more speculative shares, but things have turned around since then.
Jayamanne: The funny thing is you went on the Equity Mates podcast at the beginning of 2022 and said you were really worried about valuations and talked about how you built up cash. Then the market fell substantially in the US, and you got awarded expert of the year. And now you're saying you were wrong. So, are you going to give the award back, Mark?
LaMonica: I mean, it's literally the only award I've ever won in my life.
Jayamanne: Where do you keep it?
LaMonica: It's sitting by my television, actually. It's kind of embarrassing. But yeah, no, I'm not going to give it back. It was voted on, Shani. And the Equity Mates listeners voted. And unlike another American who won't shut up, I'm not trying to actively subvert the democratic process. But as I said, I wouldn't make the same decision again. Yes, the market in the US fell meaningfully. But the problem was that most of the shares that dropped so much were things I would never buy anyway. And larger dividend paying shares actually went up. So, it didn't really give me the opportunity to buy much, although I have spent down the cash that was built up since that time. So ultimately, I want to buy quality businesses that grow dividends over the long term. Should have just stuck to that strategy. I was right about the market falling without getting any benefit out of being right.
Jayamanne: And this is where your strategy plays a part. For instance, if you are a passive investor who wants to get the market return, and you've calculated your required rate of return and set an appropriate asset allocation, just keep getting money into the market as you save more. You've elected to get the market return, which has been very successful to build wealth over the long run. Yes, the market has gone through down periods, but the chances of you are picking the right spots with your investments is rare. And over the long term, the market has done well.
LaMonica: And if you're picking individual shares, I think that Buffett quote rings true on a case-by-case basis. Yes, valuations matter on individual shares, as a Morningstar study showed. And you may have to go searching a bit to find good opportunities in certain markets. But chances are they are out there because you don't face the same constraints as Buffett. So, Berkshire is so big that his opportunity set is really small. Most of us don't have that problem. But be patient with those individual opportunities and wait until you find the right opportunities and don't invest like the money is burning a hole in your pocket. Make sure you have an investment policy statement that outlines your strategy and criteria for things you buy and don't deviate from that.
Jayamanne: And this advice probably only holds true if you have a substantial portfolio where building up a bit of cash isn't that relevant. If you are just starting out and have a really long time horizon, the most important thing is to get money into the market.
LaMonica: And that is who the time in the market, timing the market quote is really aimed at. Get started early. Let the money compound. A 60-year-old with a substantial portfolio is not going to invest the same way as a 25-year-old waiting for the right time to make their first investment. There's a difference between having no money in the market and having a large portfolio and holding 12% cash instead of 10% cash. Keep your goals as the context to make decisions.
Jayamanne: The other thing to add is that no matter what approach you're taking, make sure you are controlling what you can control. Don't trade too much if it's based on market timing or any other reason because you want to minimize taxes and transaction costs. That Morningstar study looked at valuation levels and returns, and it didn't include taxes and transaction costs in that result of undervalued markets outperforming overvalued markets. The picture would be very different if those costs were included. That is one thing that didn't happen for Mark regardless of how much he regrets his decision. He wasn't selling anything.
LaMonica: Okay. Well, I think that's enough regret for this podcast. I can now go back to silently regretting most of my decisions without telling the world about them. So, it's always be thoughtful about what you are doing as an investor. Thank you very much for listening. We really appreciate it. My email address is in the show notes if you have any comments or questions or episode requests, and we would love any ratings or comments in your podcast app. Thank you.