Market Timing Is a Losing Game

08/21/2007 12:00 am EST


David Fried

Editor, The Buyback Letter

David Fried, editor of David Fried's Buyback Letter, explains why investors should not try to time the market, especially in volatile times like these, but should stick with their investing strategies.

Investors are busy doing the usual when they fear a bear market. As July ended they jumped out of equities and into bonds and money markets in at a feverish rate. These investors are trying to time the market, and I'm betting against them. If you won't listen to me, consider the legendary Peter Lynch, former head of the Fidelity Magellan fund, who took that fund on its storied, meteoric rise in the 1980s.

"The only problem with market timing is getting the timing right. I haven't met many people who've done it successfully. Maybe once in a row, but not consistently. There is no telling how many timers miss big gains in stocks by making ill-timed exits," he said in a 1997 article in Money Magazine.

Lynch [favored] dollar cost averaging, in which [an investor] buys the same dollar amount of stock with each purchase. That way, the investor is able to buy more shares when the market is down and fewer when the market is high.

Our [own] research shows that companies-like individual investors who dollar-cost-average-buy more of their own shares when the market is down. This means there are fewer of their shares available after a market decline. And according to  the laws of supply and demand, less supply equals higher prices.

Thus, everything else being equal, a portfolio of companies that buy back their own stock will outperform the market the most in the months after large market declines. So unless you can pick the absolute bottom of the market, you are likely to miss out on the biggest gains.

As seasoned investors, all of you know that the market is cyclical. It goes up, it goes down, but exactly where it's going to be on any given day is anyone's guess. If you were timing the market and you had missed the 40 months with the largest gain in the Standard & Poor's 500 stock index over the past 50 years, your annual returns would have been just 2.7% versus 11.4% for a buy-and-hold strategy. You would have been better off with your money in a savings account.

Indeed, many market timers warned at the beginning of 1995 that the S&P's run-up of more than 71% from its 1990 market lows made it appear to be topped out. The market made a fool of those timers by having an unprecedented five-year run. While we can't guarantee there aren't more declines in the coming weeks or months we would be surprised if the recent market high represented a long-term top.

The big-picture message is simply this: do not try to time the market.

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