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Does Market Timing Work?

Seth Jentner04/17/2012

Legendary portfolio manager, Peter Lynch, famously said, "The real key to making money in stocks is not to get scared out of them."

Since World War II, the U.S. stock market has provided positive returns almost four out of five years.  Just over one out of five years was a bear market, suffering a temporary decline averaging about 30 percent.  There have been about 13 bear markets since World War II. But just before the first of these bear markets, the S & P 500 peaked in 1946 at 19.3.

65 years later the S & P 500 is around 1200, some 60 times higher.  Based on this, wouldn't the majority of investors during these momentous years enjoy enormous success and wealth?

No!  Why not?  It's because people confused volatility with loss, and got scared out of the market.

In my own 30 years of experience, I have observed that it's not just a matter of how the market performs, and it's not just the quality of your investment advisor's advice, but it's equally important how you as an investor behave.

I have also learned that whether times are good or bad, emotions are more powerful than logic.  During good times, people tend to get greedy and are tempted to take too much risk.  During challenging times, people become fearful and are tempted to move into cash.  This is called market timing and does not work.

John Bogle, the founder of Vanguard, said, "I never met anyone who can successfully time the market.  I never met anyone who knows anyone who can successfully time the market."

We recommend prudent investors recognize the significant benefit of staying fully invested throughout the various market cycles.  By investing in the right mixture of cash, bonds, and stocks, you develop an investment portfolio that has the right combination of risk and reward, enabling you to successfully stay invested through the ups and downs.

Therefore I recommend diversifying into cash, bonds, and stocks using low cost, tax efficient index funds.  The more volatility you are willing to accept, the more your portfolio can be tilted toward equities.  The less volatility you are willing to accept, the more your portfolio can be tilted toward fixed income.  By avoiding the temptations of greed and fear, you increase your odds of successful investing throughout retirement.

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