The Myth of Market Timing
July 5, 2019
Did you know that emotional behavior is one of the biggest barriers to better returns in your investment portfolio? That’s right. It doesn’t matter how educated you are, how successful you are in business, or how disciplined you may be in other areas of your life — we can all give in to emotions that work against our best financial interests.
Take market timing, for example. Investors can fall into a couple of behavioral traps related to market timing that can lead to consequential portfolio underperformance:
- Short-term thinking: Driven by a desire for quick profits, investors may try to time the market with quick buy-and-sell strategies on individual stocks. Like gambling at a casino, these investors hope to make it big without losing money. I call this the Something for Nothing Club.
- Irrational fear: Investors operating out of irrational fear may try to second-guess the market by jumping out quickly to avoid losses, or by refusing to participate altogether for fear that the market is due for a downturn.
You may get lucky a time or two, but neither of these approaches is a sound investment strategy. As Peter Lynch, one of the most successful investors and mutual fund managers in America has said, “I can’t recall ever once having seen the name of a market timer on Forbes’ annual list of the richest people in the world. If it were truly possible to predict corrections, you’d think somebody would have made billions by doing it.”
Look, it’s easy to be rational about investment mistakes when you talk about them in the abstract. But when you’re faced with a huge market correction and your portfolio has declined by 30%, the rational can give way to the emotional.
How do you prepare for those times and avoid a costly mistake? Here are some key takeaways:
- Understand the common behaviors that get investors into trouble. DALBAR, Inc., the independent expert on the financial services industry, identifies nine key behaviors which contribute to subpar investment performance. I have identified a couple of behaviors here, and I’ll discuss more of them in future blog posts.
- Identify your own triggers for emotional decision-making, and tame them. Do you watch the market every day and panic at the first sign of decline? Are you tempted to jump on every new investment opportunity you hear about? If you can identify these tendencies and wean yourself of them, you might just save yourself some money and improve your blood pressure in the process!
- Build up your Emotional Armor®. My free, comprehensive Emotional Armor® handbook outlines in depth how to avoid behavioral pitfalls in your investment decisions. Find it here.
- Employ a long-term, buy-and-hold strategy. DALBAR finds a clear correlation between long-term investment retention and higher average returns.
- Work with a financial advocate who will rein in your emotional impulses. For many people, the best way to keep emotion out of investing is to hire a professional who will take a rational approach to the management of their investment portfolio. In my book, You Are the Boss, I explain how to identify a financial professional who will protect your interests.
I don’t believe that you can eliminate all emotion from investment decisions. Rather, the goal is to keep emotions in their proper place and balance them with reasoned analysis, education, and mental preparedness. These things comprise the Emotional Armor® you’ll need to realize the benefits of a true buy-and-hold investment strategy.