Can You Time the Market?

After watching 70% of his retirement savings evaporate in the 2000-02 bear market, Bob Parrish was determined not to leave what was left to the mercy of the investing gods. So he fired his financial adviser and decided to try something most experts say you should never do: time the market. "Most people thought 2000 was the beginning of a secular bear market," says Parrish, using a term that describes a prolonged downturn. "People said you could still make money, but instead of buy and hold, you had to take a different tack." So he vowed to buy only when he thought the market was headed upward and to bet against it at other times.

Parrish, a retired human-resources executive with an MBA, is no babe in the woods when it comes to finance. He caught most of the market's gains from 2003 to 2005, turned bearish a bit too early in 2006, and with a portfolio entirely invested in bear-market mutual funds (which gain value when the stock market tumbles), he doubled his money in 2008. Since 2002, he reckons, his portfolio has gained an annualized 23%. "While everyone else has been crying in his beer, I've been a happy camper," says Parrish, 64, who lives near Sacramento, Cal.

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Parrish's disenchantment with traditional buy-and-hold investing is understandable, given recent results. If ten years ago you had invested $10,000 in a low-cost mutual fund that tracks Standard & Poor's 500-stock index, stuck with it and reinvested dividends along the way, you would have been left with just $8,416 as of May 31. No wonder many restless investors (and more than a few advisers) are dismissing buy and hold as something that works during long bull markets, such as the one that began in 1990 and ended in 2000, but not now. "Buy low, sell high has two parts, and most of the world focuses on just the first part," says Will Hepburn, a Prescott, Ariz., money manager and president of the National Association of Active Investment Managers, whose 200 or so members practice a variety of alternatives to buy-and-hold investing.

Certainly, if you could master the second part of Hepburn's equation -- knowing when to get out -- you, like Parrish, would be sitting pretty. A chart on Hepburn's Web site shows that if you had owned the S&P 500 from 1983 through 2003, but somehow managed to miss the 30 worst days during that period, you would have earned an annualized 19%, almost double the 10% buy-and-hold return.

Easier said than done. While we agree that there's plenty of evidence that market timing has worked over short and even long periods, the devil is in the details. It's a tougher strategy to pull off than buy and hold, and few do it well. Even Parrish, who has made it work, admits, "I'm savvy enough to recognize I've been very fortunate and that it's not going to last."

Our take on timing

Mark Matson, a Cincinnati money manager, likens a market-timing strategy of switching between stocks and cash to "playing Russian roulette with two bullets in the chamber. The idea that some market timer is going to save you from the crashes while getting you all the upside from great markets is a fantasy."

We're not as dead set against market timing as Matson, but neither are we ready to throw in the towel on buy and hold. We think buy-and-hold investors could incorporate some mild forms of market timing to improve their results. But first, let's take a closer look at market timing to see why it is so alluring to frustrated buy-and-hold investors.

Successful market timing requires three key ingredients: a reliable signal to tell you when to get in and out of stocks (or bonds, gold and other types of investments), the ability to interpret the signal correctly and the discipline to act on it. The popular image of market timing is that it calls for making drastic, all-or-nothing moves into and out of a particular market.

In reality, many timers adjust their investments in stages, and their recommendations don't always reflect such a black-and-white view of things. And while some timers may trade frequently, others use signals that rarely change from buy to sell or vice versa. In any case, timers say that being out of the stock market during its most uncertain periods results in a smoother ride for your portfolio compared with a buy-and-hold approach.

Three kinds of signals

Academics and economists claim to have discovered a number of signals that have proved surprisingly predictive of market turning points in the past. The indicators fall into three broad categories: