Most People Don’t Appreciate How Important Market Timing Is Until They Think About It a Bit

Published on

Practice market timing (that is, lower your stock allocation when valuations go very high and increase it when valuations go very low) and you will lower the risk of stock investing by 70 percent. Wade Pfau and I showed this in research we had published in a peer-reviewed journal. Everyone wants to lower the risk of stock investing. So everyone engages in market timing today.


No, that’s not so. Only a small percentage of the investing population engages in market timing. The Buy-and-Holders have argued that it’s a bad idea and most of us have bought into what they say. I have been trying to change people’s minds re this matter for 21 years now and have seen only limited success.

I have made some converts who have become effusive advocates of timing. But I have also been banned from more web sites than I can count for making the pitch. So saying that I have achieved limited success is putting it kindly.

Engaging In Market Timing

What’s the story? Why do so many stock investors not do what is in their best interest?

There are two big reasons.

One, there is widespread confusion over what it means to engage in market timing. When most people hear the term, the thing that comes to mind is this silly practice in which you try to guess when prices are going to turn and profit by guessing right. That really doesn’t work for the obvious reason that it’s pretty darn hard to guess right. Market timing has gotten a bad reputation because there is one form of it that really doesn’t work.

The kind of market timing that always works is the practice of changing your stock allocation in response to big price swings for the purpose of keeping your risk profile constant over time. How could keeping your risk profile constant (Staying the Course in a meaningful way) ever not work? Of course that form of market timing works.

Why don’t people see it?

The reality that market timing always works is a bit counter-intuitive.

In one sense, it is entirely intuitive. Practicing market timing is practicing price discipline. There are thousands of markets out there. In each and every one of them, price discipline is absolutely essential. It shouldn’t be too much of a surprise to learn that the same is true in the stock market.

But there is also a good reason why people don’t see it that way.

Overvaluation is irrational. If investors were acting in their best interests, there would never be any overvaluation. Given how important investing is to our hopes of being able to retire someday, it’s hard to accept that stocks can become so overvalued that market timing offers a significant edge.

I love market timing. I believe that it always works. I believe that it should be heavily promoted. But I acknowledge that it is more than a little nuts that it works. It shouldn’t work. The market should be efficient, just like the Buy-and-Holders say. I believe that the Buy-and-Holders are wrong about an important element of the stock investing puzzle. But I acknowledge that what they say is logical (the problem is that investors are not logical but at times highly emotional).

If we can get to a place where market timing is heavily promoted, we can greatly diminish the extent of both overvaluation and undervaluation. A market with fewer crazy ups and downs would be a more rational market, a more efficient market. Investors who have experienced what the market has become during the Buy-and-Hold Era would be impressed by the change and would in time grow in their conviction that market timing makes all the sense in the world.

We just are not there yet. It takes a good bit of thinking the thing through to assemble the logic chain in today’s world. So the Buy-and-Holders still usually get the better of the argument.

Rob’s bio is here.