Hopefully, we all know by now just how bad an idea market timing or day trading is but even with all the evidence, some folks still continue to play this game and expect us to follow suit, hoping that we will get them out of the market in time before the next correction happens. So should we heed their advice and at least attempt to market time? Absolutely not because we know just how impossible the math is.
Let’s start with a simple scenario. Assume that a hypothetical investor bought a large company stock fund like S&P 500 on January 1st, 2014 and held on to that investment till December 31st, 2014. And hypothetical because no investor will and should invest in only large company fund, potentially exposing his portfolio to more asset class risk than necessary but let’s go with this for now. His total return for the year was about 13.7%. But had he missed the five best days of the year, his return drops to just 3.2%. That investor accepted all that volatility and came out about the same as what he could have earned in a decent bond-type investment.
But what if that investor was on top of what was happening in the markets all the time and thought he had a very good feel for what the market was going to do next and got out in time just before the five worst days of the year. His return for the year would be about 26.4%. That’s great but what are his odds of achieving that i.e., missing the five worst days. Running through the numbers…there are about 200 trading days in a year so the odds of this investor getting out in time before the 1st worst day in the market is 1/200 or 0.5%. Small, right? And the chance that he successfully navigates out of the market for the first as well as the second worst days…1/200 x 1/199 = 0.0025%. Missing the third worst day…1/200 x 1/199 x 1/198 = 0.00001%. Continuing along, we know that this investor’s odds of correctly timing the five worst days are so close to zero that well, you get it.
So the choice for investors is clear. To remain invested through thick and thin and capture 100% of what the markets will deliver, often times with a lot of volatility or take a chance with trading in and out of the markets, hoping to miss the bad days for that faint chance to double that annual return.
The math is there and the choice is yours but we will not change how we invest.