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One timeworn piece of investing advice is to “buy low, sell high.” Sounds easy, but as a strategy, timing the market — anticipating when the market as a whole or a particular security (stock, bond, etc.) is at a high or low — is fraught.
What is market timing?
Market timing is the practice of trading in and out of the stock market or certain asset classes based on predictions of future price movements. Followers of this strategy target buying low and selling high by attempting to strategically time their trades in an effort to beat the market.
For example, if the stock market steadily climbs and hits new highs over a long period, investors may believe that a pullback is imminent and try to time their exit with the intention of avoiding a market downturn. If a drop occurs, the next step would be to predict when the market will bounce back, trying to get in beforehand to ride that wave back up.
Investors use different tools to try and predict future price movements. Some use technical analysis or the study of past market data, such as price trends and trading volume, to forecast future price action. Others use fundamental analysis, scrutinizing a company’s business prospects and financial statements to project how the stock will move over time. There are many leading indicators that investors track to gauge sentiment and signal what lies ahead for the market. (Learn more about stock research.)
Timing the market vs. time in market
Though investors might occasionally be able to make the right call, consistently placing the correct bet at the most opportune time is nearly impossible without a crystal ball. And there are real consequences when market timing doesn’t work out. In the example above, if an investor gets out of the market too early or a market drop never materializes, they could miss out on significant additional positive returns by having gotten out.
A 2020 report from investment management company BlackRock illustrates a $100,000 investment in the S&P 500 from 2000 to 2019, and the difference in investment returns when staying invested over the entire time frame versus missing some of the good days in the market.
Staying invested — spending more time in the market, rather than trying to time it — yielded better results over the long term. Even though investment returns would have fallen during downturns, staying the course allowed the investments to recover when the market rebounded, continuing to compound and grow.
When trying to time the market, investors must constantly watch market movements in an attempt to make the optimal trades. Besides being time-consuming, a more active trading strategy could mean higher trading costs and potentially additional tax consequences for investors. For those reasons, along with likely reduced returns, many advisors suggest using a buy-and-hold strategy that focuses on time in the market rather than trying to time the market.
When emotions get the best of you
Aside from not being able to time the market exactly right, there can be other reasons investors miss out on good days in the market or end up not executing on “buy low, sell high.”
Over the course of a year, the stock market trades up and down. It’s common for investors to encounter various pullbacks, whether it be a dip of 3% to 5%, which typically can happen several times a year, or a more significant stock market correction, characterized by a 10% to 20% drop from a recent market high.
Using the “buy low” rule of thumb, investors can get their shop on during these times. But as the stock market falls, investors often grow anxious watching their portfolio’s value come down and opt to get out and convert into cash. This results in investors doing exactly the opposite of what they sought to — they sell low. Once out of the market, investors wait on the sidelines until they feel comfortable getting back in, often after the market has already rebounded — which means they buy high.
Why does this matter? Because once a stock is sold at a price lower than where it was bought, investors succumb to investment risk, locking in a permanent loss of capital.
Taming the temptation to time the markets
Every investor wants the best possible return on their portfolio, and some might be tempted to time the market in pursuit of this goal. Weathering the ups and downs of the market can be tough to stomach during volatile times. But there are ways investors can stay calm, cool and invested.
Mind your asset allocation
Making sure your portfolio has an appropriate asset allocation is key to reducing investment risk. Asset allocation means spreading your investable dollars across various asset classes or categories of investments — stocks, bonds, cash — based upon your goals, risk tolerance and time horizon (the amount of time you have to invest). Diversification takes this one step further, breaking those asset classes down more into subcategories such as by market capitalization (size of a company), geographic location or style (growth versus value-oriented companies).
As the market moves, the best-performing asset class this year might be the worst-performing next year. Sometimes stocks will be up and bonds down, but other times it flip-flops. By investing in different asset classes, investors typically gain protection against market volatility. And being well-diversified can further reduce risk, because it’s less likely that one investment will derail your entire portfolio.
Understanding why you’ve safeguarded your portfolio with asset allocation and diversification can help provide peace of mind, helping to quell emotional urges and the itch to time the market.
Use dollar-cost averaging
Investors can also achieve better pricing when investing through strategies like dollar-cost averaging, which means spreading your stock or fund purchases out over time, buying approximately the same amount over regular intervals. As the market moves, you’ll buy more shares when the market is down and fewer when the market is up, which can smooth out your average purchase price over time.
Work with an advisor
Another option is to rely on the guidance of a seasoned financial advisor. Financial advisors help you create a plan for reaching your financial goals, recommend appropriate investments and provide ongoing investment advice.
If you might be prone to feeling anxious about the markets, having an advisor take the reins or hold your hand can be invaluable to help you stay on course with your investments. Depending upon the level of service you desire, you can choose an advisor who will fit your needs.