Should you rethink your ‘Timing The Market’ strategy?

Synopsis

Market timing refers to the strategy of attempting to predict the future movements of financial markets to maximise profits. Market timing is a challenging strategy to execute successfully as financial markets are complex and influenced by numerous factors. Experienced investors suggest Investing in a diversified portfolio over the long term.

Introduction

Market timing refers to the strategy of attempting to predict the future movements of financial markets, such as stocks, bonds, or commodities, in order to make buying or selling decisions. The goal of market timing is to enter or exit the market at opportune times to maximise profits. Investors who engage in market timing believe that they can predict short-term market trends based on various factors, such as economic indicators, technical analysis, or news events. They try to identify periods when the market is likely to rise or fall and adjust their investment positions accordingly.

The Study

We did a study to find out how beneficial market timing would have been for two investors who are identical in all other respects except one believes in timing the market and the other in investing through auto mode via normal Systematic Investment Plans (SIPs).

The Considerations

We consider the following for this study-

1. We call the two investors Mr. Auto (SIP investor) and Mr. Active (market timer).
2. Both investors invest in India’s oldest headline Index - the Sensex.
3. We take a long investment period of 30 years to avoid any market phase biases from our study. A 30 year period is long enough to invest throughout the earning phase.
4. Both investors started investing from Jan-1993 and continued to invest money on a monthly basis from their savings till Dec-2022.
5. Both investors start investing Rs. 5,000 monthly and increase their investments annually by Rs. 2,000. Accordingly, each of them invest Rs. 60,000 in 1993, Rs. 84,000 (Rs. 7,000 *12) in 1993. By this way, in the least year of their investment journey in 2022 each of them invest Rs. 7,56,000 (Rs.63,000 * 12).
6. Mr. Auto invests his money at the beginning of every month irrespective of market levels. Mr. Active follows a rule of investing the money at the bottom level of the market every month (timing).

The Results

We get the following results-

1. Each of Mr. Auto & Mr. Active invested a total principal of Rs. 1,22,40,000.
2. Mr. Auto’s value of total investment at the end of 2022 amounts to Rs. 6,46,68,820. This results in a Annualised Returns (XIRR) of 12.45%.
3. Mr. Active’s value of total investment at the end of 2022 amounts to Rs. 6,78,81,317. This results in a Annualised Returns (XIRR) of 12.76%.

The Analysis of Results

Let us see the differences  between the two-

1. Mr. Active’s extra absolute earnings in the 30 year period is Rs. 32,12,498 (Rs. 6,78,81,317 - Rs. 6,46,68,820) over Mr. Auto.
2. Mr. Active’s extra percentage earnings in the 30 year period is 4.97% [(Rs. 6,78,81,317/ Rs. 6,46,68,820) * 100] over Mr. Auto.
3. Mr. Active’s extra Annualised Returns (XIRR) over Mr. Auto is 0.31% (12.76% - 12.45%).

So, you see that by all means Mr. Active has done slightly better than Mr. Auto.

Assumptions of Study

Now let us see what Mr. Active had to do better than Mr. Auto in order to earn this extra-

1. Mr. Active perfectly timed the bottom of the market every month continuously for 360 months.
2. Mr. Active watched the market actively on a daily basis to time it perfectly. He did this along with his professional & personal life.
3. The months in which the market hit their lows in the beginning to mid of the month, Mr. Active perfectly knew that a particular price is the bottom point even if the markets were going to open a few more days in the ongoing month.
4. The months in which the market hit their lows at the end of the month, Mr. Active perfectly knew that the markets were going to hit lows at the end only not getting swayed by market movements during the month.
5. Mr. Active received his full salary timely throughout the period of 30 years. There were no unpaid leaves or employment gaps, etc.
6. Behavioural biases, Geopolitical situations, Economic indicators, Technical analysis,  News flows, Brokerage reports, mental fatigue, ill-health, etc. did not affect the decision making of Mr. Active.

Each of these skills alone seem nothing less than God's extraordinary grace. Mr. Active possessed and applied all of them perfectly to earn around 5% extra over 30 years. Is it possible for you to do it? Are the rewards exciting enough to do it?

The Reasons behind the Results

Why was Mr. Auto only slightly behind Mr. Active despite putting in so much effort? There are two fundamental reasons that might help you to save your efforts in case you believe in timing the market that Mr. Active might not have known-

1. Buy Low Sell High Syndrome

You have learnt to buy low and sell high to make profits. While it makes sense to make profits by buying something at a low price and then selling it at a higher price, the price at which it should be bought and sold remains an unanswered question. You see stock markets are forward looking whereas valuation models that predict whether the market is high or low at a particular point in time is based on historical data. For example, if the Nifty is trading at its all time high you will read that the market is high and if the Nifty is at its 52 week high, you will read that the stock market is low. Now, these all time high and 52 weeks low figures are based on historical data. However, in reality, these prices should be looked at in terms of the financial performance of the companies that constitute the Sensex. For example, Sensex may be at its all time high but still be worth investing if the financial performance of the companies has been better than the price at which Sensex is trading. If it would not have been so, Sensex would have never crossed its all time high! Similarly, Sensex may be at its 52 week low but still not worth investing in if the financial performance of the companies does not justify the price at which Sensex is trading. If it would have not been so, Sensex would have never breached its 52 week low! Valuing companies and Indexes requires time, effort and expertise. That is not everyone’s cup of tea. So, the easy way out is to look at historical data and guess over/ under valuation. This can be termed as just an educated guess based on historical data.

1. All asset prices generally increase over the period

Assets are termed as assets either because they have the potential to provide an income or increase in value. Some assets rise in a linear fashion. For example, non tradable debt instruments like a Fixed Deposit. You see a Fixed Deposit makes an all time high in its value on a daily basis without making any noise unlike stock markets. Stock prices are tradable therefore they go up and down on a recurring basis. However, if we take a long-term view of 10 years or more, they generally go up in a prosperous economy as stocks are also assets. That’s why as you extend your investment horizon, timing becomes less and less relevant for making long-term returns.

Greatest Investors on Market Timing

What some of the world’s greatest investors of all time have said about market timing? “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.” Peter Lynch “The idea that a bell rings to signal when to get into or out of the stock market is simply not credible. After nearly fifty years in this business, I don’t know anybody who has done it successfully and consistently. I don’t even know anybody who knows anybody who has.” Jack Bogle “Though tempting, trying to time the market is a loser’s game. $10,000 continuously invested in the market over the past 20 years grew to more than $48,000. If you missed just the best 30 days, your investment was reduced to $9,900” Christopher Davis

Conclusion

It is important to note that market timing is a challenging strategy to execute successfully. The financial markets are complex and influenced by numerous factors, making accurate predictions consistently difficult. Even experienced investors and professional fund managers often struggle to consistently time the market effectively. Attempting to time the market carries several risks. You may miss out on potential gains if you exit the market during periods of growth or buy in at high prices. Conversely, you may incur losses if you sell during a market downturn or miss out on buying opportunities during market upswings. Additionally, frequent trading can lead to increased transaction costs, such as brokerage fees and taxes. Instead of market timing, practise long-term investing with the belief that markets tend to rise over time despite short-term fluctuations.