« Lunch Bunch for Saturday, April 26 | Main | Investing Like Yale »

May 01, 2008

Market Timers Creep Out of the Woodwork

Have you ever been driving around, listening to the radio, when you hear something so offensive, so wrong, that you can't help but scream? That happened to me last Saturday afternoon. 

I was driving home from our after-show "Lunch Bunch" when I heard a financial advisor - on the same station my show comes on - tell his listeners that we should trust him because he said to get out of the market back in November. He said if everyone had done as he advised, we'd all be happier right now amid this market volatility.

Several other so-called advisors are on the airwaves warning of an impending recession. "Get your money out of the stock market now," they say.

These advisors are suggesting that they can properly time the market. And they want you to pay them a hefty premium to do it.

Why the myth persists

Why do so many think you can successfully time the market? Because we hear about the successful calls all the time. Elaine Garzarelli correctly predicted the stock market crash of 1987. Ralph Acampora became famous for predicting the dot-com bubble. We don't hear about all the market calls they made that didn't come true. But because they got it right once or twice, the media treat them as geniuses.

You're probably familiar with the phrase, "Even a stopped watch is right twice a day." It's the same for many market timers. Abby Joseph Cohen is always bullish, and when she turns out to be right, she's labeled brilliant. Roger Babson is credited with predicting the stock market crash of 1929. But he was giving doom-and-gloom speeches throughout the 1920s, even as the market reached historic highs year after year. When the crash happened, suddenly he was right.

I've even heard stories from friends in the financial services industry that the big firms keep analysts who make opposite calls, just so they can point to the one who gets it right.

The evidence

So our radio financial advisor friend correctly predicted when to get out of the market. Congratulations. But to be a successful market-timer, you can't just know when to get out. You also have to know when to get back in. And that's no easy task. There's about a one-in-ten chance of guessing it correctly, according to Vanguard's John Bogle. He tells William A. Sherden in The Fortune Sellers:

To make money, you have to make two market calls: one to get near a low point and one to get out near a high one, which means that your chance of success is about one hundred to one (one-tenth times one-tenth). And, doing it twice has a one-in-ten-thousand chance of succeeding.

…

In the 30 years in this business, I do not know anybody who has done it successfully and consistently, nor anybody who knows anybody who has done it successfully and consistently. Indeed, my impression is that trying to do market timing is likely not only not to add value to your investment program, but to be counterproductive.

Bogle's impressions are supported by several studies, one of which is from Dalbar. Their Quantitative Analysis of Investor Behavior has, for many years, shown how investors shoot themselves in the foot trying to chase returns. In other words, impulsive investors. But market timers do even worse, according to their 2004 study:

Although the S&P 500 on average grew by 13 percent over that 20-year sample, Market timers actually lost money.

And these financial advisors are suggesting that timing the market is a good thing?

By getting out of the market, as these advisors suggest, you may avoid losing some capital in the short term. But you're almost assured of missing out on the gains when the market starts going back up. According to a study from SEI Investments, the majority of a bull market's gains come in its first few days and weeks. If you wait until you see the market turn, you've already missed a golden opportunity.

From The Wall Street Journal:

SEI looked at the dozen bear markets since World War II. If you held stocks at the market bottom, you made an average 32.5% over the next 12 months. But what if you bought one week after the bottom? Your gain was trimmed to an average 24.3%. Meanwhile, if you didn't buy until three months after the market bottom, your gain was just 14.8%

So what do we do?

I have no idea whether we're headed for a recession or a prolonged bear market. I don't have a crystal ball, and I'm not in the business of predicting the future direction of the stock market. What I do know is that the stock market is the best place for long-term growth over time, just not all the time. Trying to time the market is a fool's errand.

Any advisor who tells you otherwise is either lying or sadly misguided.

SOURCES:

1. Dalbar Inc., Quantitative Analysis of Investor Behavior, 2004.

2. "It's Time to Prepare Yourself for an (Inevitable?) Bull Market." Getting Going, The Wall Street Journal, Oct. 23, 2002. http://online.wsj.com/article/SB1035309775900025391.html?mod=googlewsj (accessed April 30, 2008)

3. Sherden, William A. The Fortune Sellers: The Big Business of Buying and Selling Predictions. New York: John Wiley & Sons Inc., 1998.

---

Kim Snider is the President and Founder of Snider Advisors, an SEC Registered Investment Advisor, focused on teaching individual investors a sensible, long-term investment approach focused on maximizing cash flow. For more information on Snider Advisors or the Snider Investment Method and how to stop enriching your investment advisors at your expense, please visit snideradvisors.com. Her book, How to Be the Family CFO: Four Simple Steps To Put Your Financial House in Order, will be in bookstores October 1, 2008.

Snider Advisors makes no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 866-952-0100 to request the Snider Investment Method® Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments, including the Snider Investment Method™ are subject to risk, including possible loss of principal.

Posted by Kim Snider on May 01, 2008 | Permalink