Market timing and its record

In short

A friend of mine sold everything during a bad spring and told me he felt smart for a whole week. You have probably felt that pull too, the urge to step aside before the drop and step back in before the climb. Market timing means trying to move money in and out of investments based on a guess about what prices will do next. The record of people who try it is not kind, and that is no shame on you, because the task is hard for everyone. A steady plan, low costs, and a long stretch of time are the parts you can actually control. This guide shows how timing works, what it costs when it goes wrong, and what questions to settle before you act.

The whole of it

What it is

I once watched a man at a county fair try to win a prize by guessing when a spinning wheel would stop. He was sure he could feel the rhythm. He was not the first to think so, and he would not be the last.

Market timing is much the same idea, only with real savings on the line. The timer tries to sell before prices fall and buy back before they rise. If it worked every time, nobody would need a plan. Everyone would just ride the waves.

The other approach is often called buy and hold, or staying invested. You put money in on a schedule and leave it there through good years and bad ones. It sounds dull. It also asks you to sit still while prices drop, which is much harder than it sounds.

You want your money to grow so that you can live the life you have in mind. That is a fair wish. The question is which path leaves you with the fewest ways to trip.

How it works

A neighbor of mine once told me that timing has to be right twice. I still turn that over in my head. The timer must pick the right day to get out. Then the timer must pick the right day to get back in. Miss either one and the result can be worse than doing nothing.

Here is why the second choice is so tricky. Prices often jump hardest right after they have fallen the most. Those big up days can land close to the big down days, in the same rough patches. So a person who steps out during the fear may miss the very recovery days that mattered most. Then the money sits in cash while prices climb without it.

Think of it as a short list of days that carry a lot of weight. Miss a handful of them and the final result can change a great deal. Nobody rings a bell before those days arrive. You only learn which ones they were afterward.

There is also the matter of cost. Every time you sell a holding in a regular taxable account, you may owe tax on the gain. If you held it one year or less, the gain is taxed as ordinary income, which can mean a higher rate. If you held it longer than a year, it gets the long term rate set by law. Trading in and out can turn a small mistake into a bigger bill. Trades inside an account that shields growth from tax, such as an IRA or a 401(k), do not trigger that same yearly bill. The missed recovery can still hurt.

Then there is the human side. Fear and excitement pull hard. When headlines are grim, selling feels like relief. When they are bright, buying feels like joining a parade. Both feelings push people toward buying high and selling low. That is the opposite of the goal. It happens to careful people too.

The numbers, and where to find yours

You do not need a fancy model to look at your own case. You need a few plain figures, and most of them sit on statements you already have.

Start with your account balance and how long you have until you need the money. A goal ten years away calls for a different mindset than one thirty years away. Next, find out whether the account is taxable or tax deferred. Your statement or plan website will say. If it is taxable, look at how long you have held each investment, since that decides whether a sale is taxed as short term or long term.

Then look at what you pay in fund fees, called the expense ratio. The fund's prospectus lists it, and so does your plan website. The rules that set your yearly contribution limits, and the tax rates on gains, come from the law. For the contribution limit on your workplace plan, the figure is the current figure, which the official source publishes each year. For the IRA limit, it is the current figure, which the official source publishes each year. The long term capital gains rates that apply to you are set out at the current figure, which the official source publishes each year. The IRS publishes these on its own site, and the site fills in the checked number with its source and date.

Do not trust a figure you cannot trace. If a page cannot tell you where a number came from, be careful with it.

A worked example

Let me tell you about a woman I will call Ruth. She is forty, earns 52,000 dollars a year, and puts 6 percent of her pay into her workplace plan. Her employer matches 3 percent.

Her yearly saving is 52,000 times 0.06, which is 3,120 dollars. The match is 52,000 times 0.03, which is 1,560 dollars. Together, 3,120 plus 1,560 comes to 4,680 dollars a year going in.

Say her balance is 40,000 dollars when a sharp drop hits, and it falls by 20 percent. She loses 40,000 times 0.20, which is 8,000 dollars, leaving 32,000 dollars. Ruth panics and sells. She now holds 32,000 dollars in cash.

Suppose prices then rise by 25 percent over the next stretch. Had she stayed, her 32,000 dollars would grow to 32,000 times 1.25, which is 40,000 dollars. Back where she started. But Ruth sat in cash, so she still has 32,000 dollars. She is 8,000 dollars behind the version of herself who held on.

Now here is the part that stings. A fall of 20 percent needs a rise of 25 percent to break even, because 32,000 must climb back to 40,000. Ruth would have needed to buy back in at just the right moment, and she had no way to know when that was. To be fair to her, she acted out of care for her family. Her instinct was decent. The method was the problem.

These are made up figures, chosen to be easy to check. Real markets do not follow a tidy script. But the arithmetic shows how one badly timed step can cost real money.

Where it goes wrong

I have heard many folks say they will get out when things look shaky and get back in when things look safe. It sounds sensible. The trouble is that safe rarely looks safe until prices have already risen.

One common slip is selling after a fall. By then the loss has already happened, and selling makes it permanent. Another is waiting for the perfect moment to return, which can stretch into months or years. A third is trading often, which piles up costs and taxes.

Another slip is trusting a confident voice. Someone always called the last drop correctly, and people remember. What they forget are the many calls that missed. A good guess once does not prove a method.

There is a quieter mistake too. Some people stay out of the market entirely out of fear, and their savings lose ground to rising prices. Doing nothing carries a cost as well.

Life does shift. You may need money sooner than planned, or your comfort with risk may change. Adjusting a plan for those reasons is one thing. Guessing what prices will do next is another. Keep the two apart in your mind.

Questions to answer before you leave this page

When do you actually need this money, and does a bad year between now and then put your plans at risk? Do you know whether your account is taxable or tax deferred, and what a sale would cost you in tax? If prices dropped by a fifth next month, what would you honestly do, and have you written that down while you feel calm? What do you pay in fund fees, and did you find that figure on a real statement or prospectus? Are you thinking about a change because your life changed, or because a headline scared you? Could a steady schedule of contributions, set up once and left alone, spare you from making this choice on your worst day?