Because you have to buy at the right time AND sell at the right time.

If ever there was a year to show investors that market timing is truly a fool’s errand, it was 2016. Why should you care about what happened way back in 2016 when we’re in the dog days of the summer of 2017? Here’s why: just look at what the market did – and didn’t do – as proof that market timing just doesn’t work.

Even if you get lucky and manage to guess the outcomes of headline grabbing events, that’s only part of the equation. Knowing how the market will react to those same events is equally, or perhaps more important, and nobody knows that. Investors need to recognize that they shouldn’t be so preoccupied with when the best time to invest is, but instead manage the behaviour that leads them to buy high and sell low over and over again.

Before we get ahead of ourselves though, let’s be sure we’re all on the same page as far as what market timing is. It’s an investment strategy where investors make predictions on what the market will do in the future and then base decisions on when to buy or sell financial assets (typically stocks) on those predictions.

Overconfidence epidemic

It’s important to realize that in any given year there will always be events that cause a great deal of uncertainty – “what if?” scenarios will constantly be dancing in investors’ heads. Left to their own devices, investors typically don’t fare very well in situations like these. Emotions and the instinctual need for certainty get in the way of even the most steadfast investors making good investment decisions. Throw in a little market volatility for good measure and it’s a recipe for disaster.

There are lots of well-known reasons for this like:

• Much as they try to fight it, investors behave irrationally directly impacting the market’s ability to behave rationally

• There’s no consistent way to accurately predict when the market will go up or down (or by how much) so knowing the best time to buy and sell isn’t possible

• Investors’ instincts and emotions often have them buying and selling at precisely the wrong times

• Unexpected events hit, well, unexpectedly and have unexpected consequences

As much as investors like to think they can predict what the market is going to do in the future, there’s a lot of research to show that isn’t reality. In fact, people tend to overestimate their abilities in general with studies showing that everyone thinks they’re above average in pretty much everything! Like 80% of drivers think they’re above average. Not only is that mathematically impossible, one look at the roads and you see there are a lot more bad drivers out there than really good ones.

Don’t get us wrong, we’re all for people having high self-esteem, but overconfidence has disastrous repercussions for investors. For instance, their overconfidence lends itself to tunnel vision where they no longer consider other points of view believing instead they have all the answers. It can also lead to an underestimation of risk causing them to jump head first into (or out of) something without properly assessing what could happen if they’re wrongii.

Where does that leave investors as far as their success at market timing? Below is a chart that demonstrates that when the market is up, investors pile in (chasing performance) and do the exact opposite (sell) on the downturn. This isn’t the kind of timing that builds wealth, rather it destroys it in fairly short order.

Sources: Investment Company Institute, Morgan Stanley Capital International and Bloomberg LP.
1 Net-new cash flow to previous month to U.S. equity fund assets (as defined by the Investment Company Institute) is plotted as a six-month moving average.
2 Total equity return is measured on a one-year moving average basis in the MSCI All Country World Daily Gross Total Return Index.

Going back to 2016, using our EdgePoint Global Portfolio, we illustrate how damaging market timing can be. Investors who got cold feet prior to the Brexit vote missed out on 96% of the calendar year return as a result. Similarly, if you look at the chart below, investors who took the wait and see approach and went to cash before the U.S. election missed out on 68% of the Portfolio return – meaning almost 70% of the investment performance for EdgePoint Global came in the last seven weeks of the year despite predictions that a Trump victory would send markets into a prolonged tailspin.

Annualized returns as at July 31, 2017

In dollars and cents terms, take a look at the growth of $15,000 invested in EdgePoint Global Portfolio of those who bought and held compared to those who missed out on the best days. It’s clear that market timing is risky business. Missing just 25 days out of 2,965 days results in a loss of $32,372!

Hypothetical investment of $15,000 in EdgePoint Global Portfolio, Series A. Total return in C$.
Period of investment: November 17, 2008 to December 31, 2016.

We’re being awfully hard on the average investor but make no mistake, we’re the first ones to admit we can’t predict what the market is going to do either. We’d love to tell you we always buy right before a stock rockets upwards and always sell before it drops but we never expect that to be the case, and that’s one of our predictions we tend to be right about. Below are a bunch of companies we bought that were down at least 10% during our holding period. Warning: column two ain’t pretty, but we think you’ll find column three more to your liking.

We’ve admitted we’re not good at market timing and investing is our full-time job. How’s the average investor supposed to get it right if we struggle with it? If at this point you’re wondering why you’re invested with us, here’s something that should bring you some comfort. Instead of trying to time the market, we look for businesses that can grow in varied circumstances and not pay for that growth. We do this by spending countless hours researching businesses and their competitors, meeting with management teams, attending industry conferences and evaluating the potential risks first and foremost before we think of the potential rewards. It’s not to say as soon as we see a business that ticks our boxes that we buy it right away. We’ll wait to buy it when we think the timing is right but that is in no way based on predicting the future. It’s based on the price we can buy the business for today compared to what we feel the business is worth. That’s our version of marketing timing, if you can call it that.

Market timing isn’t always an intentional strategy. Emotions of fear and greed will dictate when investors buy and sell as often (or more often) as any algorithm or strategy. Regardless, both can result in investors being out of the market when considerable gains occur. As shown above, missing out on even a handful of "best days" can have lifelong consequences for you and your investments. We know we can’t accurately predict the best time to buy or sell or what the market is going to do on any given day. We’d suggest investors don’t try to do it either.

Don’t predict the rain. Build an ark.