Most brokerage firm and mutual fund websites have articles to inform us of the dangers of trying to time the stock market, meaning that they discourage any effort to move into and out of the market in an attempt to participate in the good times, and to miss out on the bad times.
At first glance this seems like noble advice, but it is often provided in a manner which excludes half of the truth. The gist of most of this material is to show you how little your investment plan will make if you miss out on the best 25, 50, or 100 days of the last 20 years, and therefore imply that you need to stay invested at all times so you won't miss out on these very best days.
The complete story would include the fact that well over 70 percent of the very best days for the stock market have historically occurred when the market is in decline, during a period known as a bear market, which generally means a drop in excess of 20 percent. It is these same periods of time which also contain well over 70 percent of the very worst days, meaning that to participate in the best days, you’ll also participate in the very worst. Multiple studies have confirmed this.
Two concepts strike me when considering the ramifications of this fact:
1. Studies show that the 100 worst days totally erase the impact of the best days, meaning that unless you are sharp enough to jump in and out of the market on a daily basis, you obtain no benefit from participating in the very best days.
2. The very best and worst days are concentrated in small periods of time usually near the end of significant market declines when the volatility is extreme and investors are susceptible to emotional decision making - which usually leads to mistakes like selling when the damage has already been done.
I'm not trying to say that a buy and hold approach to investing won't work - it has been time proven that it will. But a buy and hold strategy requires that the investors complete the "hold" part of the process, even when things get scary and you may have doubts about the very survival of the financial system like we experienced in 2008. For many, this is just too much to ask.
Perfect market timing is also a pipe dream since there is no such thing. However, utilizing some simple trend following rules could allow you to avoid some of the more extreme periods of volatility and avoid some of the emotion induced decision making which usually ends badly.
I'm happy to share a simple research piece that illustrates how the best and worst days are clustered together and how they tend to cancel each other out over time. There is no obligation. Email Andria Ludlum ( firstname.lastname@example.org ) and request the 100 Best Days Research Paper, and we'll be happy to email you a copy.
The most important thing is to have a plan to follow, whether that is a buy and hold approach, or a method involving some rules based timing. Good luck and good investing.
Tom Breiter is president of Breiter Capital Management, Inc., an Anna Maria based investment advisor. He can be reached at 778-1900. Some of the investment concepts highlighted in this column may carry the risk of loss of principal, and investors should determine appropriateness for their personal situation before investing. Visit www.breitercapital.com.