Avoid the Timing Trap

For even the most resolute equity investors, 2008 was a tough year. Problems in the banking sector related to the availability of credit, combined with a slowing economy, caused problems in the markets that inspired many investors to seek safer ground.

However, investors who fled stocks in October after a painful eight-day, 23% slide in the S&P 500 may have also missed a major 12% one-day gain that followed on October 13.¹ This illustrates the point that episodes of falling prices can be clustered with episodes of rising prices.

Market timing is an attempt to forecast the market’s direction, pulling money out in anticipation of a downturn and reinvesting when it seems likely that prices will move higher. The events that move markets are usually unpredictable. Therefore, market timing is a risky approach that could have a significant effect on a portfolio’s long-term performance.

Because no one can predict exactly when the markets will fall sharply or begin to rise again, investors who try to time the market often make emotional decisions that cause them to sell at market lows and buy again later after missing the opportunity for significant recovery. The chart shows what might have happened to an investor whose attempts to time the market over a 30-year period caused her to miss the best 12 months.

If bouts of market volatility have led you to question your risk tolerance, or if your personal financial situation has changed, some adjustments to your portfolio’s asset allocation may be warranted. Even so, it may be wise to carry out any changes over a period of time in order to avoid emotional decision making.

1) Yahoo! Finance, 2008. S&P 500 for the month of October 2008. The performance of an unmanaged index is not indicative of the performance of any particular investment. Individuals cannot invest directly in an index. Past performance is no guarantee of future results.