Wednesday, May 22, 2024

Does timing the market work? If it does, does it pay?

 Does timing the market work? If it does, does it pay?

I tested this concept by creating a simple backtest.

I assumed that four different investors were able to put away $1,000/year at various points in the S&P 500 ETF (SPY) since 1993 through end of 2023. They all use a tax-deferred account, pay no commissions, and reinvest dividends. 

Investor A puts $1,000/year into S&P 500 ETF at the first available close price for the year

Investor B puts $1,000/year into S&P 500 ETF at the highest available close price for the year

Investor C puts $1,000/year into S&P 500 ETF at the lowest available close price for the year

Investor D puts $1,000/year into S&P 500 ETF at the last available close price for the year

As of last month, this is the total worth for each investor:

Investor A is worth $207,000.72

Investor B is worth $177,796.12

Investor C is worth $228,001.77

Investor D is worth $187,997.16

The conclusion that I have is to avoid timing the market. Even if you are consistently able to buy at the low of the year, every single year (which is impossible to do), you are not really that better off than someone who simply bought everything at the beginning of the year

And if you are afraid you will always buy at the top (which is also consistently impossible to do), you are not that far off either.  

If you look at it from a position of each individual year however, there is big variability. But looking at market only on a single year's worth of data is incredibly short term. It's noise.

For example, if you bought $1,000 worth of S&P 500 at the bottom in the year 2022, you returned over 7.50% in that year. You would become famous for timing that one single bottom and making money in a bear market, when everyone else lost money.

If you bought at the beginning of 2022, you would have lost 18.70% for that year on and your clients and everyone else would be laughing at you.

Yet, if you continued investing each year, your overall results won't be as huge, particularly when you get new capital added each year.  Adding that new capital each year smooths out things for you.

When you start averaging out, and stacking those investments year in and year out, brick by brick, you are in effect zooming out. You are taking a longer term approach and building wealth.

After all, in order to make money with market timing, you need to make several correct decisions.

The first one is when to sell.

The second one is when to buy back what you sold.

This sounds complicated, because it is. There are too many variables at play with a market timing strategy.

I believe that a simple strategy of buying right, and sitting tight is superior to a market timing strategy, mostly because it is simpler. When you have less variables, you reduce your chances of error.

To summarize, investing on a regular schedule beats trying to time the markets. For as long as the investor puts money in a diversified portfolio on a regular basis, over a long period of time, it hasn't really mattered if they bought at the top or the bottom.  

Hence, it makes sense to keep investing regularly, and stick to that investment process through thick or thin.

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