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Why does time in the market matter more than timing

05 Jan 2023

What do we understand as the difference between time and timing. To understand this difference one needs to look at the difference between speculation and investing. Speculation is trying to take a bet on the future direction of the market and positioning your trades accordingly. On the other hand, investing is all about focusing on the quality of the asset and holding on to it for the longer term. That is the fundamental difference between timing the market and time in the market. When you try timing the market you are effectively speculating on the market direction. We will see in greater detail if that is a workable proposition or not. On the other hand, when you focus on time in the market it is more like investing where you let the quality of the asset and the power of compounding work in your favour.


So what exactly is the difference between trading and speculation? In this debate of trading vs. speculation, let us also understand empirically why trying to time the market rarely works in practice. One also needs to understand the subtle difference investing trading and speculation and grasp that timing the market is more like speculation and less like trading. But first some empirical home truths about trying to time the market..


Is timing the market possible based on the views of experts?


                                                Source: Bloomberg


The above chart captures the implied forecast for the S&P 500 index returns over the last 17 years along with the actual return generated by the index. The result signifies a huge disparity. For the years 2000, 2001, 2002 and 2008 the consensus forecast for the S&P 500 was positive whereas the actual S&P returns were sharply negative. In the remaining years, the actual returns have been close to the consensus returns only or 2 or 3 occasions. What is goes to show is that the entire effort of trying to time the market using the opinions and consensus estimates of experts is hardly likely to improve your performance.


Missing the handful of High Return days..
Another way of looking at the power of time in the market over timing the market is to look at what would happen to your returns if you had missed out on the handful of real high return days. The results are actually quite surprising. Consider the chart below..


                                                        Source: FTSE


The above study was done in the UK markets. This covers the 30 year period from 1986 to 2016 on the FTSE index. If you had invested the money in 1986 in the index and left it at that, an investment of £100,000 would have grown to £1.828 million by 2016. That is an appreciation of 18.28 times in a span of 30 minutes. Instead, if you had chosen to time the market and missed out just the 10 best days during these 30 years, your accumulation would have actually halved. This shows how vulnerable returns are to whether you capitalize or miss out on the handful of days; something which is almost impossible to do even assuming that you have an uncanny sense of timing the market.



The above chart on market is a lot more revealing. Over the last 20 years between 1996 and 2016, the S&P 500 index has returned 7.68% annualized compounded returns. In the process of timing the markets, if you had missed the 10 best days then your annualized returns are lower by over 350 basis points. In fact, if you had missed the 30 best days, then your returns are actually negative. So much for your ability to time the market!


Why does time in the market work better than timing the market?
There are 5 reasons why time and patience works better in the market than trying to time the market…

It is said that in the short run the stock market is a slotting machine but in the long run the stock market is a weighing machine. Over a longer period of time, quality stocks held on tend to outperform any kind of aggressive strategy for timing the market. Over the longer run, the vagaries of the markets tend to get smoothened.

Transaction costs make a big difference to a timing strategy. When we talk of transaction costs, we refer to brokerage, statutory costs, taxes, exit loads in case of mutual funds etc. When you add all these up the actual economics of timing the market can change quite drastically.

Timing the market is very vulnerable to the handful of good days and bad days in the market. Over a period of 10-15 years, there will be days when the markets will either spurt sharply or correct sharply. In the process of timing the market if you miss out on these good days or if you happen to buy on the bad days, your timing concept can grossly underperform. This is what actually happens when you try to time the market.

When you try to time the market you tend to get carried away by the hype in the media and the analyst community. Normally, the media and the analyst community tend to create a sense of hysteria around stocks which may not really materialize. That hysteria is essential to create interest but in the process you may end up hurting your portfolio.

Time in the market gives you a sense of perspective. When you time the market you tend to get too involved with the market vagaries at a short term level. Instead, if you take a longer term approach you are able to invest when valuations are attractive and vice versa. This sense of perspective works in favour of time in the market over timing.        

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