Confessions of a Closet Market Timer

A lot has been written and studied on the concept of trying to time the market to buy and sell stocks. Mountains of research and ink have been spent to show that it is extremely difficult to pick the optimal sweet spot of time to buy or sell a stock. It is essentially a fools game and people who claim and peddle to others they have been able to do it successfully are either lying or have done so but have not very consistently. I have also always held strongly to the premise that there is no point in trying to market time. Many financial experts have suggested adopting a dollar-cost averaging method as a way to ensure that at least you can be close or in the neighbourhood of the optimal time through spreading or averaging your costs. I also have in the past seen value of dollar-cost averaging more from a risk management perspective than a maximizing profit perspective. We have also seen the emergence of passive management strategies through use of Exchange Traded Funds (ETF’s) or before that Mutual Funds that promote “buy it and hide it” or other couch potato styles of investing, again to avoid the temptation in market timing and to guarantee participation in most of the future wealth generated.

These all seem to be sane and rational approaches to making investment decisions, but then one day when I was sitting in a café having an espresso (actually I was just sitting at home watching a football game and drinking some orange juice) it dawned on me that in reality is not every investment decision we make, even the ones that are cloaked around a strategy like dollar-cost averaging or passive investing still a form of market timing? Am I just a closet market timer?

I was thinking that every investment decision I have made has taken place as a snapshot in time from which I can derive future performance and associated comparables. When I have bought a stock on the dip to average down my cost, I made a conscious decision that this particular moment in time was “ideal” to put my investment in a more profitable position. Isn’t that market timing? If it is the case then every investment decision is a market timing decision? If the stock pops back up and increases my profit, I look like a genius, but if the stock keeps falling, am I an idiot or an idiot for buying more stock because now I feel we have reached another timing point to average down even more? Even passive investing incorporates an element of market timing. The last 13 years provides a stark example. If you started investing in 2000 at height of the dot com bomb or at in 2006-07 just before the financial crisis and forgot about your investments, then you would not be a happy camper compared to someone who started in the depths of those periods.

My investment strategy has evolved over the years to be more mindful about behavioural aspects in that I am always gauging market and investor sentiment (through my observations on our Consensus Watch Blog ) and often going against the herd. In other words, when the market is feeling giddy about stocks I will tend to stay away and vice versa. Wouldn’t that be considered a market timing type of behaviour?

I am thinking that this whole obsession with timing the market is irrelevant mainly because we are all doing it anyway at some level. It seems like it is part of our DNA. As humans we very much want to be on the winning team. Furthermore, we are also greedy and want to squeeze as much profit as we can. Market timing feeds on these inherent human behaviours. As a result, I think we are all closet market timers and so we should get over it and accept it.

Recently, market observer Barry Ritholz wrote about this whole concept of market timing. He observed that investors should focus on more risk management issues that impact the timing of investment decisions such as trending of basic macroeconomic variables (interest rates, inflation, GDP etc) as well as market technical and trends (i.e. earnings trends and asset valuations). Mr. Ritholz’s observations feed nicely into the whole concept of the Behaviour Gap, which was coined by Financial Advisor Carl Richards. The Behaviour Gap is the difference in the nominal return of an investment (i.e. the returns the mutual fund companies post in the newspaper) and the actual return an investor generates (i.e the return you see on your annual statement). For example the S&P500 index may return 10% during a calendar year, but if you invested two or three months into the year, your return maybe higher or lower than that 10 percent. We all suffer from this gap. That difference is driven by our behaviours and timing. Mr. Richards goes into depth into explaining how we can reduce our personal behaviour gaps and most of those solutions involve establishing better personal discipline toward whatever strategy we adopt combined with better risk analysis and observation of the stock market and economic sentiments, which play into Mr. Ritholz’s perspectives. Both are reasonable approaches.

As investors, we need to nurture and develop within our DNA many of the tenants Mr. Ritholz eloquently alluded that revolve around understanding the risk variables that will drive the extent of the timing of our decisions which will determine our behaviour gap and our investment success. As much as we can get up on our soap boxes and spread the gospel to avoid trying to time the market, the reality is even though we think we are not timing the market, we are … and as a closet market timer, I am OK with it.