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Why timing the market is a bad idea [video]

Janette Rutterford is a Professor of Finance at the Open University Business School.

RP: Quit the stock market at the top and buy back in again at the bottom. It sounds great doesn’t it?

But while the temptation to try to time the market is considerable, the reality rarely lives up to the promise.

Janette Rutterford is a Professor of Finance at the Open University Business School.

JR: If you think that markets are efficient, that means that share prices reflect everything you or I know about the share. All the information that we’ve got has already been priced in. So how do we know what’s going to happen tomorrow? Because tomorrow we might have good news — the prices go up — or we might have bad news — and the price will go down. The point is it’ll be new news and we can’t forecast it.

RP: The financial markets and the global economy are not only vast; they’re also intricately complex.

One of the problems, Professor Rutterford says, is that we instinctively want to make order out of chaos.

But it’s not a reasonable expectation.

JR: Because the human brain likes to find a pattern… a sense to things, randomness doesn’t suit us, we don’t like to think that tomorrow: what’s going to happen to us is entirely random. We like to think we’ve got control over the world. So that’s the problem, we think we can see patterns in past share prices, we think we can see movements going out so we think — if we buy here, if we bought here last time, we’d have made money, so why don’t we do the same thing this time with the same picture: we’ll be rich! But of course, that’s a different environment, different things will happen, and you won’t make money.

So all these things are biases in our behaviour, which come from generations back of behaviour and there’s not much we can do about it. But the best thing to do is keep your portfolio long-term and, on the whole, you will do reasonably well.

RP: Behavioural experts have shown how the pain of losing money is generally greater than the pleasure we derived from making it.

With equity investing, you can lose money, at least on paper, very quickly.

That’s why many investors panic when markets fall.

The key is to have a much more long-term focus.

JR: If you look at shares and bonds and cash over 15 or 20 years, it hardly ever happens that shares don’t do best out of that because, over the long-term, shares will give you a higher return because you’re taking slightly more risk in the short-term volatility sets. The share price can go up and down and if you have to sell on a particular day, you might not make as much money as you expected. But in the long run, you will do very well with shares because, on the whole, they earn a higher return. So if you’re looking at 15 or 20 years — or even for your pension, it might be 40 or 50 years — then shares should be a part of your portfolio.

RP: This approach might sound simple. But it’s often not so simple in practice.

Having a financial adviser, or at least someone you can turn to for an objective opinion, when you’re not necessarily thinking straight, is extremely valuable.

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