Tuesday, August 17, 2010

Timing The Market?

Market Timing is one of the all-time great myths. There is no strategy that consistently tells you when to be in the market and when to be out.

There is a study in the February 2001 issue of Financial Analysts Journal, which looked at the difference between buy-and-hold and market-timing strategies from 1926 through 1999 in the US using a very elegant method.The authors mapped all the possible market-timing variations between 1926 and 1999 using different switching frequencies.

They assumed that for any given month, an investor could either be in T-bills or stocks and then calculated the returns that would have resulted from all the possible combinations of those swicthes. For the curious, there are 4096 possible combinations between two assets over 12 months.They then compared the results of a buy-and hold strategy with all the possible market-timing strategies to see the percentage of the timing combinations produced a return greater than simply buying and holding.

The answer is about one-third of the possible monthly market-timing combinations beat the buy-and-hold strategy. However, given that stock market returns are highly skewed eg the bulk of the returns (positive and negative) from any given year comes from relatively a few days in that year, the risk of not being in the market is high for anyone looking to build wealth over a long period of time.

Thus, I would not recommend anyone to use a market-timing strategy to manage your DIY portfolio for the long term. Having said this, this is not the same as saying that you should never sell your stocks. We will look at a future post on when you should consider to sell some of your stocks.

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