You've finally done it; you've correctly timed the market. Let all those who doubted you wait in line as you autograph hypothetical portfolios and Morningstar reports.
For the average investor, correctly timing the market may be the Holy Grail. However, you may still be wondering why your portfolio returns are far from exceptional.
According to the Dalbar's 2015 Annual Quantitative Analysis of Investor Behavior (QAIB) the average equity fund investor correctly timed the market in eight out of 12 months in 2014. This 67% success rate may give an investor, or advisor for that matter, a false sense of victory.
Eight wins in 12 games is a record the hapless Miami Dolphins would be proud of, but for the average investor in 2014, this ratio would underperform the S&P 500 by more than eight percentage points (5.50% vs. 13.69%).
If I'm getting it right, why am I underperforming?
According to Dalbar's QAIB, the average equity fund investor timed the market correctly 67% of the time but underperformed overall based on the volume of buying and selling at the right times. In short, when you get it wrong, you get it very wrong.
A Prudential article on market timing has a great example on how getting it wrong, even some of the time, can drastically alter your portfolios overall return. According to Prudential, an investor who was fully invested in the S&P 500 from January 1995 to December 2015 would have had an annualized return of 8.19%.
By trying to time the market, an investor may miss some of the stock market's biggest gains. In fact, Prudential states that an investor who missed on only 10 of the best trading days between January 1995 and December 2015, experienced an annualized return of 4.49%. This annualized return falls to 2.05% when missing on the 20 best trading days and -0.04% when missing on the 30 best trading days.
Yes, you've read correctly. Potentially missing on only 30 trading days in a 20-year time frame could be the difference between an annualized return of 8.19% and -0.04%. To put this in dollars, staying fully vested in the S&P 500 from January 1995 to December 2015 would have allowed $10,000 to grow to $48,250. Conversely, missing only those 30 very important trading days over the same 20-year period, would have allowed $10,000 to be worth $9,912.
Market Timing in 2016
The conversation for 2016 has largely been to exploit the volatility and take advantage of the dips. You have to be able to ask yourself, "How many times (Or months) am I going to get it right this year?" "If I'm wrong, how wrong am I going to be?"
Certainly, if you were wrong in the first two months of 2016 you could have potentially sold in January and been on the sidelines for the run-up in February and March. Prudential showed us that being wrong only a small number of times, can have a big impact on long-term returns. Furthermore, a winning record of timing the market may not necessarily mean outperformance.
According to Dalbar's QAIB the average equity fund investor underperformed not only in 2014, but over a five-,10-,20- and 30-year time horizon by trying to time the market. The age old saying of, "It's not timing the market but time-in the market" holds true time and time again. It would even be reasonable to say that when timing the market, "Even when you're right, you're wrong."