Now There's More Evidence Against Market Timing
Market timing: Don't do it; you'll only lose money. Most of us have heard this conventional investment wisdom, and now there's more evidence to back it up.
Morningstar, the investment rating and research firm, recently did the math to provide solid supporting evidence for this advice. A few weeks ago, they announced the results of a study titled Bad Market Timing Reduces Investors' Returns that calculated investors' returns during the past decade; these are collective returns for all investors in the company's mutual fund database, based on investors' total cash flows in and out of these mutual funds. Then they compared these investor returns with the total returns that these funds publish, not weighted for cash flows. The total return measures the changes in the value of a fund over the measurement period, assuming the investor reinvested all distributions and held the fund for the entire period. The gap between the investor returns and the published total returns indicates how well investors timed their purchases and sales.
Over the past decade, considering all mutual funds, the investor return was an annualized 1.68 percent, compared to 3.18 percent for the total return. So if you'd invested $100,000 proportionately in all the funds in their database at the beginning of the decade, you'd have $18,630 more in assets if you had simply bought and held them, compared to moving in and out of them as investors did in the past decade. There was a similar pattern for the past three- and five-year periods, with the total returns also exceeding the investor returns for these periods.
Looking just at equities, the investor return was an annualized 0.22 percent, compared to 1.59 percent for the total return. If you had invested $100,000 proportionately in all the equity funds in their database at the beginning of the decade, you'd have $14,865 more in assets if you had just bought and held these funds. Again, there was a similar pattern for the past three- and five-year periods.
The culprit? Two devastating bear markets followed by "snap back" rallies. You can guess what happened; people panicked and sold during the downturns, then missed the rallies.
Interestingly, investors in balanced funds, which invest in a mix of stocks and bonds, did better than investors in equities and all funds combined over the past 10 years. These investors realized an annualized investor return of 3.36 percent compared to an annualized total return of 2.74 percent. In this case, if you had invested $100,000 proportionately in all the balanced funds in their database at the beginning of the decade, you'd have $8,126 more in assets by adopting the tactics of the average investor in balanced funds. The reasons: Investors in balanced funds tend to stay put, even through bear markets. Also, they must have timed their purchases well over the past 10 years to beat the total returns. But investors in balanced funds shouldn't get too proud; for the past three- and five-year periods, the Morningstar study showed that total returns in balanced funds exceeded the investor returns, once again providing evidence of poor market timing decisions.
I'm a big fan of a balanced asset allocation for my retirement investments, as you can tell from my previous post Asset Allocation: My Grandfather Had It Right. Balanced mutual funds provide most investors with a simple way to get professional investment management and the discipline to stick with your asset allocation through bull and bear markets.
For me, here's the takeaway: Decide on an asset allocation between stocks and bonds that makes you comfortable, and stick with it in good times and bad. If you're like most people and have trouble managing your own portfolio, seek a low-cost, no-load balanced mutual fund with a good track record. (Morningstar's web site is a good place to compare costs and track records of thousands of mutual funds.) You may not hit home runs, but you'll do pretty good. Then arrange your life so that doing "pretty good" with your investments is all you need to achieve. Don't put yourself in a position to need high returns and the risk that comes with them.
This investment philosophy may sound timid and boring, but it's much better than being broke at age 75 with many years to live!
Steve Vernon
View all articles by Steve Vernon on CBS MoneyWatch»
Steve Vernon helped large employers design and manage their retirement programs for more than 35 years as a consulting actuary. Now he's a research scholar for the Stanford Center on Longevity, where he helps collect, direct and disseminate research that will improve the financial security of seniors. He's also president of Rest-of-Life Communications, delivers retirement planning workshops
and authored Retirement Game-Changers: Strategies for a Healthy, Financially Secure and Fulfilling Long Life and Money for Life: Turn Your IRA and 401(k) Into a Lifetime Retirement Paycheck.
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