Investors have the opportunity to increase their rate of return by timing the market when investing in bonds, stocks, or mutual funds. They can invest profitably when stock markets go up and adopt the policy of selling before they decline. A good investor can either time the market prudently, select a good investment, or employ a combination of both to increase his or her rate of return. However, there is a higher risk involved in any attempt to increase your rate of return by timing the market. Those investors who actively try to time the market should realize that, sometimes the unexpected does happen and they could lose money or forgo an excellent return.
The fact however is that timing the market is difficult. To be successful, you have to make two investment decisions correctly: one to sell and one to buy. If you get either wrong in the short term you are out of luck. In addition to this, investors should realize that:
- When stock markets decline they tend to decline very quickly. That is to say that, short-term losses are more severe than short-term gains.
- Stock markets go up more often than they go down.
- The bulk of the gains posted by the stock market are posted in a very short time. In short, if you miss one or two good days in the stock market you will forgo the bulk of the gains.
However all investors are not good market timers. “The Portable Pension Fiduciary,” by John H. Ilkiw, noted the results of a comprehensive study of institutional investors, such as mutual fund and pension fund managers. The study concluded that the median money manager added some value by selecting investments that outperform the market. The best money managers added more than 2 percent per year due to stock selection. However the median money manager lost value by timing the market. Thus, investors should realize that market timing can add value but that there are better strategies that increase returns over the long term, incur less risk, and have a higher probability of success.
One of the reasons why it becomes so difficult to time the market correctly is due to the difficulty of removing emotion from your investment decision. Investors who invest on emotion tend to overreact: they invest when prices are high and sell when prices are low. Professional money managers, who can remove emotion from their investment decisions, can add value by timing their investments correctly, but the bulk of their excess rates of return are still generated through security selection and other investment strategies. Investors who want to increase their rate of return through market timing should consider a good Tactical Asset Allocation fund. These funds aim to add value by changing the investment mix between cash, bonds, and stocks following strict protocols and models, rather than emotion-based market timing.
Thus it can be concluded that market timing is one of the most crucial factors while making an investment decision and the investor needs to watch the market carefully in order to avoid any possible losses.