The headlines scream at us relentlessly from our computers and phones, seemingly begging us to engage in market timing. "This market looks just like 1998," says one. "JP Morgan's market guru says his 'once in a decade' trade is upon us," blares another.
The advice grows more strident when the market turns volatile.
It's remarkably difficult to pick a good mix of stock and bond funds – then avoid making big changes to it. But you should. In fact, on top of my to-do list, so I can't miss it, I have six words typed in big, bold letters:
"Don't just do something; stand there."
The Perils of Lousy Market Timing
"Timing is the bane of investors everywhere," says Russel Kinnel, director of manager research at Morningstar. "Bad timing can cost you dearly. Everyone from new investors to administrators of giant pension funds and fund portfolio managers makes these errors."
Want proof? Kinnel and his colleagues calculate "investor returns" for mutual funds and exchange-traded funds (ETFs). In essence, their research illustrates the drag of lousy market timing by showing how the average dollar invested in funds did versus the total return of the funds.
The average dollar earned 45 basis points less on an annual basis over five 10-year periods through 2018. (A basis point is one one-hundredth of a percentage point.) Investors in stock funds lost 56 basis points to bad timing, investors in bond funds lost 55 basis points and investors in alternative funds lost 1.44 percentage points annually, according to the Morningstar study (opens in new tab).
That investors lag bond-fund returns almost as badly as they lag stock-fund returns is surprising, given that bond funds typically are less volatile than stock funds. But also note the relative size of the gap. Stock funds averaged 6.8% annual gains versus 3.4% for bond funds, which means market timing took a larger bite out of bond returns as a percentage.
Alternative funds, meanwhile, are extremely complex investments that often produce low returns and have low correlations with both stocks and bonds. Those factors make them difficult for investors to understand – and easy to dump when they underperform, Kinnel says.
Then there are allocation funds. Investors in allocation funds actually topped the performance of the funds they invested in, by 22 basis points. Why? Because many allocation funds are target-date retirement funds. These funds are designed for investors to hold over an investment lifetime. They're a mix of stocks and bonds that gradually becomes more conservative over time. Plus, the overwhelming majority of target-date assets are in 401(k)s and other work-based retirement vehicles that make it easy for employees to contribute monthly using dollar cost averaging.
How Can You Avoid Bad Market Timing?
Morningstar's study offers some help – in addition to the admonition not to trade too much.
It turns out that the more volatile a fund is, the more likely investors are to buy and sell it at the worst times. That makes sense. It's far more difficult to hold a fund that's losing a ton in a bear market than one that's taking a hit but isn't down as much as the overall market.
Kinnel breaks stock funds into quintiles from most volatile to least volatile. Investors in the most-volatile quintile lagged their funds by 1.86 percentage points per year. Ouch! Investors in the least-volatile quintile lagged by a mere 19 basis points.
"Boring funds are working well for people as they don't inspire fear or greed," Kinnel says.
Performance by expense ratio is similar to volatility. The average dollar in the cheapest funds lost less to market timing that those in costlier funds. Investors in the lowest-cost quintile of stock funds trailed their funds by 1.1 percentage points per year. Investors in the highest-cost quintile of stock funds lagged by 2.2 percentage points annually.
Kinnel notes that lower-cost funds tend to do much better than higher-cost funds. "Costs are good predictors of performance, so this makes intuitive sense," he says in the study.
"A second factor in good investor returns might be that low-cost funds attract savvier planners and individual investors who make better use of their funds."
Kinnel has been performing these studies for many years now. What's encouraging is that the gap between investor returns and fund returns has slowly but surely been narrowing over the years.
Perhaps we are getting a little smarter.
But we've also been in a very long bull market. It's going to be much more difficult to stay invested the next time the market tanks.
"When markets lurch, investors do worse because they make timing mistakes," Kinnel says. "Investors large and small tend to sell after downturns only to buy back in after rallies."
Being mindful of this could steady your hand and help you avoid that fate.
Steve Goldberg is an investment adviser (opens in new tab) in the Washington, D.C., area.
6 Ways a DAF Can Make Your Year-End Giving Better Than Ever
Giving appreciated assets instead of cash could be the most tax-smart move you can make with a donor-advised fund, but wait, there's more…
By Stephen Kump • Published
Life Insurance Strategies to Consider When You Own a Family Business
Not only can life insurance replace lost income, but it can help with estate taxes and provide a sense of fairness for family members who don’t participate in the business.
By Howard Sharfman • Published
ESG Gives Russia the Cold Shoulder, Too
ESG MSCI jumped on the Russia dogpile this week, reducing the country's ESG government rating to the lowest possible level.
By Ellen Kennedy • Published
New Ways to Invest in Bitcoin
Becoming an Investor ProShares Bitcoin Strategy and other ETFs offer an easier way to gain bitcoin exposure than buying the actual cryptocurrency.
By Nellie S. Huang • Published
How to Cash In on Sports Gambling
Becoming an Investor Some 27 states have launched sports-betting markets, 11 of them online. Another five have passed laws to do so.
By James K. Glassman • Published
3 New-Investor Myths That Need Busting
Becoming an Investor Preconceived notions that new investors are uninformed risk-takers are misguided. Forget games and cynicism; they need support and guidance.
By Jonathan Craig • Published
Namaste Invested: Look to Yoga to Build Your Wealth
Investor Psychology It’s uncanny how the principles of yoga apply to financial success. Here are five elements of yoga that are particularly useful for personal wealth.
By Kathleen Kenealy, CFP®, CPWA® • Published
These 2 Emotional Biases Could Kill Your Retirement
Investor Psychology Are your emotions sabotaging your retirement plans? Some basic knowledge and careful introspection can go a long way toward avoiding deadly pitfalls.
By Jack Gelnak, JD, AIF® • Last updated
Should Investors Brace for Late-Summer Volatility?
investing Many market strategists are predicting a shaky next few months of market action. Here's how to mentally steel yourself.
By Callie Cox • Published
I Still Like the Trillion-Dollar Stocks
Becoming an Investor Unlike the highfliers of the late 1990s, these trillionaires make tons of money.
By James K. Glassman • Last updated