Advertisement
Investor Psychology

Market Timing: The Importance of Doing Nothing

Investors, as a whole, actually earn less than the funds that they invest in. Here’s how to avoid that fate.

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.

Advertisement - Article continues below

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.

Advertisement
Advertisement - Article continues below
Advertisement - Article continues below

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.

Advertisement - Article continues below

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.

Advertisement
Advertisement - Article continues below

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.

Advertisement - Article continues below

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 in the Washington, D.C., area.

Advertisement

Most Popular

HSAs Get Even Better
Financial Planning

HSAs Get Even Better

Workers have more options with flexible spending accounts, too.
July 2, 2020
2020 Stock Market Holidays and Bond Market Holidays
Markets

2020 Stock Market Holidays and Bond Market Holidays

Is the market open today? Take a look at which holidays the stock markets and bond markets take off in 2020.
July 1, 2020
Find a Great Place to Retire
happy retirement

Find a Great Place to Retire

Our cities provide plenty of space to spread out without skimping on health care or other amenities.
July 2, 2020

Recommended

10 Stocks to Invest in the Health Care Revolution
healthcare stocks

10 Stocks to Invest in the Health Care Revolution

These companies are fighting disease and improving our standard of care.
July 2, 2020
17 Wonderful Work-From Home Stocks
stocks

17 Wonderful Work-From Home Stocks

Is the run in work-from-home stocks over? The pros don't think so. These 17 "WFH" stocks appear poised to continue climbing on the longer-term remote-…
July 1, 2020
Cash In With This Gaming ETF
Technology

Cash In With This Gaming ETF

Cash in on the video gaming craze with this fund.
July 1, 2020
13 Best Vanguard Funds for the Next Bull Market
mutual funds

13 Best Vanguard Funds for the Next Bull Market

Optimistic that the bounce since March is indeed the start of the next bull market? Here are the 13 best Vanguard funds to help you make the most of i…
June 25, 2020