Why timing the market is a bad idea

Why timing the market is a bad idea

Quit the stock market at the top and buy back in again at the bottom. It sounds wonderfully simple, doesn't it? But while the temptation to time the market is considerable, the reality rarely lives up to the promise, and trying can do real damage to your long-term returns.

In this video, Janette Rutterford, Professor of Finance at the Open University Business School, explains why market timing so seldom works. If you believe markets are efficient, then share prices already reflect everything investors know, with all available information priced in. What moves prices tomorrow is new news, and by definition, new news can't be forecast. That's why nobody can reliably predict whether the market will rise or fall from here.

You'll also learn why we're so drawn to trying anyway. The financial markets and the global economy are vast and intricately complex, yet the human brain instinctively wants to make order out of chaos. We dislike randomness and prefer to believe we're in control, so we convince ourselves we can spot patterns in past share prices and repeat past successes. But each environment is different, and what worked before is no guarantee of what will happen next. These are deep-seated behavioural biases, and the most reliable antidote is simply to keep your portfolio focused on the long term.

The video also explains why so many investors panic when markets fall. Behavioural research shows the pain of losing money tends to outweigh the pleasure of making it, and with equities you can lose money, at least on paper, very quickly. The key is a genuinely long-term focus. Over 15 or 20 years, and certainly over the 40 or 50 years of a pension, shares have almost always outperformed bonds and cash, rewarding investors who accept short-term volatility in exchange for higher long-term returns.

The takeaway: timing the market is a bad idea, because you can't forecast the new information that moves prices, and your own biases work against you. Staying invested for the long term is the wiser path, and having a financial adviser, or simply someone you can turn to for an objective opinion when you're not thinking straight, can be extremely valuable in helping you stick to it.

Chapters / Key points

• Why timing the market is so tempting, and so unreliable
• Why efficient markets mean prices already reflect what we know
• Why new news, which moves prices, can't be forecast
• Why our brains crave patterns in a random, complex world
• Why past success is no guide to future results
• Why the pain of losing outweighs the pleasure of gaining
• Why many investors panic when markets fall
• Why shares reward a long-term focus over 15, 20 or more years
• Why an adviser or objective third party helps you stay the course

Transcript

Why timing the market is a bad idea

Robin Powell: 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.

Janette Rutterford: 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.

Robin Powell: 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.

Janette Rutterford: 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.

Robin Powell: Behavioural experts have shown how the pain of losing money is generally greater than the pleasure we derive 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.

Janette Rutterford: 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 sense. 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.

Robin Powell: 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.