Scenario to Check a Market Timing Approach

[sengsational]

This article shows that under the scenario where you get a lump sum then take various approaches to getting it invested (or not), you do pretty well just by dumping it all in "whenever". And that strategy holds up against someone who had a perfect crystal ball!

Does Market Timing Work?

 

[karluk]

From the article:

Naturally, the best results belonged to Peter, who waited and timed his annual investment perfectly: He accumulated $87,004. But the study's most stunning findings concern Ashley, who came in second with $81,650—only $5,354 less than Peter Perfect. This relatively small difference is especially surprising considering that Ashley had simply put her money to work as soon as she received it each year—without any pretense of market timing.

The first time I ever saw this comparison of a January 1 investor vs. a perfect market timer was the very first investment book I ever read - Venita Van Caspel's The Power of Money Dynamics. In spite of some serious flaws in her advice, I owe her a debt of gratitude for giving me a basic understanding of investments.

That said, I thought this comparison was bogus when I first read it in Venita's book, and I still think it's bogus today. Why? Because the perfect market timer isn't getting credit for interest on his cash while he is waiting for the year's best time to invest. Peter Perfect gets to invest only the $2,000 that he had at the start of the year. It's as though he never heard of interest bearing savings or money market accounts.

Compare Peter Perfect with Larry Linger, who never invests in the stock market, but at least has the smarts to put his money in Treasury bills, and so was able to eek out a modest profit.

It was more obvious that the comparison was bogus in the 1980s, when I read it in Venita's book - back then it was easy to find high single digit or low double digit bank accounts. Nowadays the amount of interest being lost would be much more modest.

Still, I love this example because it's such a perfect instance of lying with statistics. The people who promote the concept of investing in stocks immediately, whenever you have cash available, are fudging the numbers, apparently just to convince nervous investors that it's ok to jump right in regardless of market conditions.

 

[Ready]

The article makes sense to me, and nothing in it surprises me. What I think is a bit gray is that the article suggests that market timing does not work, so just put all your money in the market now.

However, in the example given the investors are really dollar cost averaging their bonuses each year into the market, not putting a lifetime lump sum in. So even if one investor gets perfect timing, it's only perfect timing for one year, not perfect timing of a lifetime amount of savings over a long time period.

Suggesting that you could put all your money in the market in 2007 right before the crash and do almost as well as someone who dollar cost averages into the market beginning on 2007 for several years would certainly produce very different results.

 

[Animorph]

A little unfair in that the market timer was only allowed to buy at month end, not daily prices. And also has to invest at some point during the year.

But it does show the average cost of DCA'ing, and the potential upside of timing. And if you do it 20 times to average things out you don't need to worry too much about how you enter the market, as long as you do it.

Still a problem if you have a once in a lifetime lump sum of cash to invest.

 

[ERD50]

...

That said, I thought this comparison was bogus when I first read it in Venita's book, and I still think it's bogus today. Why? Because the perfect market timer isn't getting credit for interest on his cash while he is waiting for the year's best time to invest. Peter Perfect gets to invest only the $2,000 that he had at the start of the year. It's as though he never heard of interest bearing savings or money market accounts. ...

Still, I love this example because it's such a perfect instance of lying with statistics. The people who promote the concept of investing in stocks immediately, whenever you have cash available, are fudging the numbers, apparently just to convince nervous investors that it's ok to jump right in regardless of market conditions.

The whole things is flawed, but I'm not sure it would make a difference.

It just isn't typical that someone has $2,000 to invest at the beginning of the year. If you are accumulating, you probably get a weekly or semi-monthly paycheck, and make investments from that. So the 'crystal ball' market timer should put his/her YTD money in at the trough of the year, and keep building in a savings account until the next annual trough.

The 'lump sum' investor could not put it all in at the start of the year, it isn't earned yet. So they would hold each paycheck amount in a savings account and put it all in at the end of the year.

The DCA person goes in at each paycheck.

I'm thinking that might make DCA look better than this study, as the money is always working, it went 'all in' as it was earned. The way they do it, the DCA person is always lagging with his investments, rather than leading.

-ERD50

 

[ERD50]

A little unfair in that the market timer was only allowed to buy at month end, not daily prices. And also has to invest at some point during the year. ...

Isn't it already 'unfair' that he is able to pick the best monthly end price every single year w/o fail! If you want to go to extremes, why not the intraday absolute bottom?

I think the lowest monthly close is extreme enough to make the point. Even that requires a crystal ball.


-ERD50