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Investor Psychology

We're All Market Timers Now

Deep down, we just know that some people can time the market. So why, we think, can't we? Be careful.

The smartest amateur investors have come to recognize, as Peter Lynch and Warren Buffett concluded long ago, that it is impossible to time the market. Many of us have learned from humiliating personal experience that attempts to outfox the market can lead to spectacular failure.

Then why is it that every individual investor I know tries to time the market, and all but one of the professional investors I know -- the holdout being my brother, Ken, co-manager of Selected American Shares -- try to do so as well?

Member of the club?

You may think you're the exception, but don't be so sure. Do you ever hold on to a stockpile of cash, waiting for the "right time" to invest? Do you ever sell during a downturn intending to buy back at a lower price later? Then you, too, may be a member of the Great Market Timers Club.

And who could blame you? Guests on CNBC prattle endlessly about where the market will go next week or next quarter. What respectable investment professional doesn't have an opinion about the market's direction? Even the sainted Benjamin Graham spends a lot of time in his book The Intelligent Investor discussing when it is wise to be in the market and when it is not. The father of security analysis was really a market timer!

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Besides, we know that top hedge funds are busy timing the market by the hour, let alone by the quarter. Deep down, we know that some people can time the market. So why, we think, can't we?

I am guilty of such arrogance myself. Although I tell my money-management clients that I am not a market timer, the cash levels in my accounts are as high as 15%. Hmmm. Sure looks like market timing to me. Does this make me more money? I think so.

Indeed, it's been the interaction with 28 clients that has shown me how hard it is to eradicate the desire to time the market. One of my smarter clients, in fact, e-mailed me not long ago, stating that he wished to SELL EVERYTHING if his portfolio fell another 5%. Now, I've made him a lot of money, but why did he choose that magic number? Did he have urgent bills to pay? Hardly. It was simply that he would have been even for the year had he lost an additional 5%, and he couldn't bear the idea of losing all his early gains.

Well, I shared his pain -- but not his perspective. For what he was really saying was that his tolerance for loss in 2006 was precisely zero. In fairness, his hefty losses in the tech bubble were partly responsible for this feeling. "And when would you get back into the market if you sold?" I asked him. He didn't have a good answer and, of course, few of us do.

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Our intense aversion to loss draws us to market timing. On one level, we know the market gyrates wildly as it works its way higher over the long haul. On another, however, we are terrified that the market will vaporize our hard-earned gains and never give them back. Furthermore, the idea of allowing the market to decline 20% or 30% without doing anything strikes us as a catastrophe that borders on investment malpractice. Who can just stand by while so much money disappears?

Self-delusion run amok

The desire to time the market is also motivated by hindsight bias. We all remember those times when we just knew that the market was about to tank -- and it did. What we conveniently forget, of course, are all those times when our gut was wrong. So our selective memories encourage us to become market timers. A human being's capacity for self-delusion is nearly infinite. I should talk. I'm a market timer who denies he's a market timer.

At any rate, be careful. Just because you know you should not be a market timer doesn't mean you aren't one.

Columnist Andrew Feinberg writes about the choices, challenges and frustrations facing individual investors.