When it comes to investments, company stock prices and markets fluctuate wildly on a daily basis. A market-timer may be tempted to sell their investment too quickly to capture a small profit or to avoid a loss despite the fact that their original theories as to why the stock may grow haven’t changed at all.
For instance, since 1950 the S&P 500 has seen calendar year returns vary from 47% up to 39% down. This is where the human psychology component comes into play. If you got “unlucky” in 2008 trying to time the market and you were down 39%, it is very difficult emotionally speaking to reverse course and try to time the market by buying. But if you use the time to your advantage, market volatility starts to wash out. Looking at the same 1950-2017 period, but looking through the lens of five-year investment horizons, returns for the S&P 500 ranged from down 3% to up 28%. Even in the worst five year period, you would only have been down 3%, which is much easier to stomach than down 39%.
This is known as the “behavior gap”. Author Carl Richards states, “We’re wired to avoid pain and pursue pleasure and security. It feels right to sell when everyone around us is scared and buy when everyone feels great. It may feel right – but it’s not rational.”.
Market timing easily plays on our emotions in a way that overrides dispassionate and serious investment analysis. If there is a change in the fundamental reasons for you to believe in a stock, it is important to be willing to adjust your investments. However, market timing easily tempts us to jump out too early or stay in too long.
