Why Market Timing is a Terrible, Horrible, No-Good, Very Bad Idea


Let’s chat about the question on everyone’s mind …

What the Heck Is Up with The Market This Week?

Or: Why Market Timing Is a Bad Idea

Investors have been optimistic this year, despite a sagging U.S. housing market, 10 percent nationwide unemployment, and turmoil throughout the Middle East, particularly in Egypt and Libya.

The Dow Jones Industrial Average peaked on Feb. 18 at 12,391, and was holding a respectable — and normal — 12,213 on March 9.

Then the earth shook, and stocks plummeted — all the way down to 11,613 a mere week later, on March 16. The world held their collective breath as Japan, battered by an earthquake and tsunami, sat on the brink of a nuclear disaster. While U.S. stocks took a heavy beating — a fall of 600 points in a week! — it was nothing compared to the merciless sell-off of Japanese stocks. On March 9, the Nikkei was sitting pretty at 10,589. Within a week it was gasping for life at 8,605 — a loss of almost 20 percent.

And now, as time passes and we collectively start forgetting about nuclear Armageddon, stocks surge again — up almost 2 percent today (in one day!), to a Dow Jones average above 12,000 again. (Ah, a return to normalcy!) The Nikkei is back up to 9,206. The MCSI Japan Index Fund (EWJ), a passive fund tracking a huge basket of Japanese companies, is still down almost 12 percent from its high – but has risen 2.4 percent today alone.

(A little note about stock gains and losses — when you LOSE money, you have to GAIN exponentially just to break even. Think about it: you invest $100. You lose 50 percent. Now you have $50. You have to gain 200 percent — double your money — to get back to your original $100.)

Focus on the Fundamentals

So what happened? Why such an enormous swing over the span of a week? None of the fundamentals changed. Every company that lost stock value after the Japanese tsunami — Google, Wells Fargo, Visa — maintains the same fundamentals as they did a week ago. Their skills and talents haven’t changed. Their debt-to-asset ratios haven’t changed. Nothing changed, except that a wealthy nation in the Pacific experienced a tragic and expensive disaster from which they will ultimately recover.

So why the sell-off? Simply put, investors are speculating — gambling — about the future. They don’t know what’s going to happen; no one does. All they know is that there’s uncertainty — and when there’s uncertainty, there’s a chance to make a profit.

So they start buying and selling like crazy. Investors prone to nervousness pull their money out. Investors who love to bargain-hunt pour their money in. Trading volumes skyrocket; firms that charge $7 – $10 per trade start grinning ear-to-ear. For these firms, bad news is great news.

Of course, we live in an automated age, Not all of this buy-sell frenzy is the result of Average Joes at their laptops selling off Sony and Hitachi stocks in $1,000-dollar increments. Much of this frenzy we see isn’t done by people at all, but rather by software algorithms that are programmed to read charts, predict patterns, and make buying-selling decisions based on these patterns. These algorithms don’t take nuclear annihilation and tidal waves into account; they simply look at patterns in stock charts and trade huge sums of money based on raw data. Then Average Joe sees the sell-off on the news and thinks, “Oh man, other investors are getting scared, and stocks are starting to tank — maybe I should move my 401 (k) into cash.”

Stick To Your Guns

Unless you believe in chart-reading and other forms of sooth-saying (perhaps you can read my palm or check my horoscope for more stock picks), you — YOU, the average investor — is best off sticking to your original investment plan:
1) Allocate your assets according to your age and risk tolerance,
2) Rebalance once every year or two, and
3) Leave your portfolio alone.

In the span of the last week, the Dow Jones has crashed from 12,200 to 11,600 and then surged back up to 12,100 (today). If you were to buy or sell based on that frenzy of speculation, there’s a good chance you’d lock in your loss and miss the recovery. If you stayed the course, you’d be fine.

The more you listen to the news, and buy and sell based on what algorithms across the country are doing, the more likely you are to ruin your returns over the long run. Stick to the fundamentals of investing, and have faith in the market to recover from its momentary crashes and surges.

But I want to be part of the action!

Final note: If you have an appetite for risk and gambling — and you really want to get in on the fun! — commit a tiny amount of money to “playing” the market (and treat it like a game!) When the tsunami hit Japan, I bought two stocks: the MSCI Japan Index (EWJ) and Hitachi, Ltd. (HIT), a Japanese electronics maker. I spent only as much money as I’m willing to lose (i.e. not much!), and I consider these purchases to be “fun” money, NOT money for retirement or short-term savings.

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3 Responses to “Why Market Timing is a Terrible, Horrible, No-Good, Very Bad Idea”

  1. Invest It Wisely
    25. Mar, 2011 at 10:13 am #

    I don’t generally market time and use asset allocation to determine when to buy and sell.

    That said, I think the market meaning people in general overreacted to the news in Japan and Libya and if you had a bit of cash lying around, it might have been a good time to rebalance a bit to take advantage of the prevailing market mood of the time.

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