The world of investment advice is dominated by slogans like “it’s not timing the market, but time in the market that counts”.
And up to a point, rightly so: countless studies have found that investors who try to time the market underperform what they would have achieved by just staying fully invested the whole time. In other words: you’re not Warren Buffet, so just put your money in and forget about it.
(As an aside, that this happens to be a convenient attitude from the point of view of fund managers who get paid a percentage of whatever you have invested: it implies it’s always a good time to give them more money, and however bad it gets you shouldn’t pull it back out.)
Like most maxims, it’s mostly true – but you could seriously damage your wealth by sticking to it blindly and not appreciating the exceptions and subtleties. So let’s see how far “don’t time the market” gets you, and when you might want to deviate from conventional wisdom.
The argument for market timing
Over the last 119 years, UK shares have earned an average of 4.9% per year above inflation. Great! But your name isn’t Warren Buffet and it’s not Methuselah either, so you haven’t been investing for the last 120 years and you won’t be investing for the next 120.
Individual bad years within that last 120 mean nothing, because we know shares are meant to be a long-term investment. The general advice is not to put any money into the stock market that you might need to withdraw in the next five years, which is sensible.
What about bad periods of 20 years, though – would that make you think twice about the merits of just blindly staying invested and waiting? Just to make it a bit more real, what about the bad 20 years we’ve just lived through?
On 1 January 2000, the FTSE 100 index stood at 6268. Twenty years later, on 1 January 2020, it stood at 7286. Up! But factoring in 70% inflation over that period (according to the Bank of England), the index would have needed to be at 10,655 just to have stood still in real terms. So actually…down!
(Just to make matters worse, over the next few months it proceeded to drop another 20% – but I’ll ignore that to show I’m not cherry-picking convenient dates, and it’s not actually important for the argument I’m making.)
This isn’t the whole story: you would’ve earned dividends along the way which, if re-invested, would have got you to a total annual return of roughly 3.5%. But given that inflation over the period averaged 2.8% per year, that’s still not great is it?
“Time in the market”? Pah!
Is this just a particularly bad period? Well, yes: 2000 to 2020 are particularly bad bookends for UK investors. But the point is that multi-decade disappointments can happen, do happen, and have just happened.
So clearly, just starting investing whenever you have cash and staying invested come-what-may isn’t the cure-all it’s made out to be. It is, however, better than what most people will in reality have done: bought in 2000, sold in panic when things crashed in 2002, bought back in again when everything felt great in 2006, and sold in a panic again when the global financial markets melted down in 2008.
In other words: timing the market well is better than not timing it at all – but timing it badly is worst of all. That’s what most people do, and why “don’t even try” is generally sound advice.
(This is actually one of my 10 financial principles: read the rest here.)
So, timing the market is difficult-to-impossible, yet staying blindly invested doesn’t necessarily set the world alight either. What can we do about this?
How to time the market…the right way
There’s a balance to be struck between lurching in and out of the market based on emotion (clearly a bad idea), and sticking your fingers in your ears and pretending investing conditions are always the same (clearly wrong). Here’s how I’d approach market timing:
Develop a contrarian attitude
As we’ve already seen, most people who time the market do exactly the opposite of what they should: they get swept up in excitement and pile in when times are good and prices are high, then panic and pull out when prices fall. “Buy high, sell low” is not a profitable strategy.
This is where having a contrarian streak pays off. When everyone else is getting excited, don’t get swept along with them: get worried and wonder about de-risking.
Skepticism and being contrary for the sake of it is my natural state, so I don’t have any practical tips for how to develop this attitude. But it’s a prerequisite for everything that follows: if you’re prone to getting swept along with others, you shouldn’t attempt to time the market. In other words:
Whenever you find yourself on the side of the majority, it is time to pause and reflect.Mark Twain
Tilt your balance between attack and defence
When people talk about timing the market, they’re normally implying that you’ll go all-in or all-out. It doesn’t need to be that way at all: you can make timely adjustments your broad asset allocation without having to do anything drastic.
Howard Marks from Oaktree Capital writes:
[None of the things fund managers spend most of their time doing] help much if you get offense/defense wrong. And if you get offense/defense right, those other things will take care of themselves.Howard Marks, Oaktree Capital
For years when every market seemed to be doing well, Marks’ investing motto was “move forward, but with caution”. Makes sense: he didn’t have the knowledge to say definitively that a bust was coming, but why go aggressive when there’s more downside risk than upside opportunity?
When the market fell in 2020, Marks became more willing to adopt a posture of attack: there was less need for caution in his investments, because valuations were lower and the “frothiness” of the market had gone away.
These aren’t bold all-or-nothing calls, and he wouldn’t have been ruined if he’d been wrong. Similarly, you can drain a little of your “attack” bucket to top up your “preserve” bucket when you think the good times won’t last, then pile back in when you sense a buying opportunity.
Another way to think about this is having a range rather than a strict allocation – for example, 25-40% allocated to attack – then shifting within that range based on your feelings about the market’s prospects.
Be guided by intrinsic value
Let’s say you were in the habit of buying one investment property in your local town per year. A few years ago the yields were 6%, but now prices have gone up and the yields have fallen to 2% (these are just made-up numbers). Should you plough on anyway, because doing otherwise would be “attempting to time the market”?
No! The low yield is a signal that prices are getting expensive. The intrinsic value of the property – the rent it generates – is low compared to the price the market is asking you to pay.
Companies’ shares have an intrinsic value too – which you can calculate in many ways, but a simple one is its Price/Earnings ratio (basically, what the market is valuing the company at compared to the profit it’s making). If the company’s profit remains the same but suddenly everyone is willing to pay more for it, that might be a signal that there’s now more downside than there was.
Have opportunistic money on the side
I’ve already written about the virtues of having cash on hand, waiting to pounce when the right asset is for sale at the right price. This is market timing. And I don’t see anything wrong with it.
Don’t try to time the exact bottom or top
The one bit of market timing you should definitively, absolutely never attempt is to sell at the exact top or buy at the exact bottom of a market. For the simple reason that it’s literally impossible, other than by luck.
Logically, you can’t know what the peak of a market is until it’s already passed and your’e coming down the other side. Because markets (as a massive generalisation) tend to move down quicker than they move up, you can soon find yourself with losses if you greedily ride the wave all the way up then find yourself coming back down the other side. Far better to get out early (or at least reduce your exposure) and potentially miss some gains.
Likewise, you’ll never know what the bottom of a market was until prices have started coming up again. On this occasion, because markets tend not to rocket back up from lows (April/May 2020 being an exception), it’s better to wait until prices are picking up again before you buy. You won’t get in at the lowest possible price, but getting in too early exposes you to the risk of “catching a falling knife” and suffering further falls once you’ve bought.