Market Timing Traps and Temptations

Decades of tracking and analyzing investment portfolio returns keep telling the same story: market timing behaviors are traps. Even though we should know it was just dumb luck, can we get a round of applause for seeming to forecast last month’s surprisingly strong market returns? It’s almost (but not really) as if the market were reading our mind when three broad U.S. Stock indexes ended July 2022 with their best returns since 2020—up 9.1%, 6.7%, and a hefty 12% for the S&P 500, the DJIA, and the Nasdaq Composite, respectively.

Sweet. It’s not often we get to look like soothsayers in this fortuitous fashion. In considering the market’s dismal returns during the first half of 2022, we’ve simply been reminding readers how underperforming asset classes often surge surprisingly, just when we’re most convinced they never will. To illustrate, we pointed out that the last two times the S&P 500 Index performed even worse in the first halves of 1962 and 1970, it happened to rebound gloriously in the second halves of those same years.

The Allure and Illusion of Market Timing

Market timing seems like it should be simple—like flipping a coin, there are only two alternatives. Either you’re in the market or you’re out. But, as history and behavioral finance remind us, markets are far from simple. They’re complex adaptive systems, influenced by an ever-changing mix of economics, politics, company performance, human behavior, and the occasional act of God. Trying to account for all these variables in real time is not just difficult—it’s impossible to do with any consistency.

It’s tempting to believe that with vast computing power and endless data, we could identify repeatable patterns and time our trades for maximum gain. The evidence, however, tells a different story: finding such patterns is more wishful thinking than realistic expectation.

Take October 19, 1987—Black Monday—when international and U.S. Stock markets fell 20% in a single day. Nobel prize winner Robert Shiller surveyed investors afterward, searching for a rational trigger. His conclusion? The crash was driven primarily by investor psychology, not any obvious external cause. How do you time that?

Market Pricing: Compared to What?

Why the dramatic turnabout this July, even as national and global headlines remain relatively bleak? The efficient market theory would suggest, that it’s not whether the news is good or bad, but whether it’s better or worse than what we’ve been collectively bracing for. As The Wall Street Journal senior columnist James Mackintosh wrote:

“The drumbeat of gloom this year drove down prices, but also meant that even-worse news was required to drive them down more. When everything looks grim, the slightest break in the clouds looks like a new day.”
Of course, even as the financial press announced the strong monthly returns, there have been plenty of pundits pointing out how fleeting any “recovery” might be. After all, most of the same challenges we’ve been facing all year remain alive and unwell, which makes it easy for forecasters to convincingly call for copious doom and gloom ahead.

They may even be correct. But once again, we caution against betting on it either way. We want to avoid market timing traps that deter, not enhance, your long-term return. History is firmly on our side.

What Does the Data Say About Market Timing Traps? 

Plus, think about it this way: If expert forecasts were useful, we should see evidence that trading on them can improve your end returns. Instead, a recent analysis by Morningstar’s John Rekenthaler reinforces existing data suggesting just the opposite is true. 

Rekenthaler compared returns across five asset allocation fund categories for the 10 years ending December 2021. Four of the five fund categories were strategic stock/bond funds with a static equity exposure of between 15% to 85%. So, for example, funds with 85% equity exposure kept their 85% exposure across the entire decade, and so on.

The fifth fund category was for tactical asset allocation funds with the freedom to shape-shift their equity exposure in response to market news. In other words, “tactical investing” is a fancy name for market-timing.

If anyone could stage a successful market-timing campaign, it should be professional fund managers and their legions of high-end market analysts. Instead, for the decade ending 2021, the tactical fund category did outperform asset allocation funds that were mostly invested in fixed income (with lower-expected returns). But they significantly underperformed fund categories mostly invested in equities.

Tactical funds also had a nasty habit of disappearing entirely, which probably prevented their worst returns from even showing up in the results (even though real people lost real money in them). Survivorship rates among strategic funds were between 66%–74%, whereas the tactical funds only survived about 53% of the time.

Rekenthaler also looked at whether investors could have done well by identifying the few “winning” tactical funds ahead of time. He demonstrated that the funds’ relative rankings were so random from one year to the next, there was no way to do that. If anything, past outperformance suggested slightly worse returns moving forward. Market timing traps even catch the most seasoned asset managers.

The Broader Picture: Why Market Timing Fails Regularly
This isn’t just a one-off observation. The pattern plays out year after year, and not just among professional fund managers. The 2023 Dalbar Quantitative Analysis of Investor Behavior Study, which has tracked mutual fund investors for more than 25 years, paints a sobering picture: the average stock mutual fund investor consistently lags the market, and the average bond mutual fund investor often fails to keep up with inflation.

According to Dalbar, this chronic underperformance is largely the result of investors trying to time the market—jumping in and out based on emotions, headlines, or the latest market predictions. Unsurprisingly, these efforts rarely pay off. In fact, from 1993 through 2022, the Dalbar study shows that stock mutual fund investors dramatically underperformed broad market indexes like the S&P 500.

The Hidden Costs of Timing
It’s not just missed returns. Every market-timing move—every switch, sale, or purchase—comes with transaction costs and potential tax consequences. Over time, these costs quietly eat away at any gains and add another layer of difficulty to an already impossible task. Meanwhile, buy-and-hold investors sidestep the lion’s share of these costs by simply staying put.

The moral of the story: Whether you’re an individual investor or a professional with a Bloomberg terminal and a team of analysts, market timing is less a strategy and more a gamble. The evidence—both from detailed fund category analysis and decades-long behavioral studies—shows that sticking to a disciplined, long-term plan is far more likely to reward you in the end.

The High Cost of Missing the Market’s Best Days

Let’s take this concept a step further. One of the biggest pitfalls of trying to time the market is the risk of missing those rare but powerful stretches when markets surge. It turns out, missing just a handful of the best-performing days can devastate your long-term returns—a fact clearly illustrated by research from Putnam Investments.

Consider this: If you invested $10,000 in the S&P 500 at the start of 2007 and simply left it alone through 2022—a time that covers the Great Recession and the pandemic—you would have earned an annualized return near 9%. Steady, even with plenty of turmoil along the way.

But what if you skipped just the 10 best days out of over 3,700 trading days? Your return would have been slashed by more than half. Miss the 20 best days, and instead of growth, you’d actually have a loss for the entire 15-year period. That’s a stunning demonstration of how just a tiny fraction of days drive the bulk of market gains.

The catch? These “best days” often come sandwiched between bad headlines, when nerves are frayed and panic is in the air. Trying to dart in and out of the market to capture only the good and avoid all the bad is not just difficult—it’s nearly impossible. Even seasoned pros don’t manage it reliably.

Staying invested, rather than making repeated guesses about when to jump in or out, remains your best bet to capture the market’s long-term compounding power.

Why Staying Invested Really Matters

There’s one more trap that trips up even the savviest investors: missing out on the market’s best days. This is the Achilles’ heel of market timing.

Consider this: Over any long stretch—say, 15 years—the difference between healthy returns and disappointment often comes down to a mere handful of trading days. For example, research from Putnam Investments analyzed $10,000 invested in the S&P 500 from 2007 through 2022, a period marked by plenty of turmoil (think: the Great Recession and the pandemic). If you stayed fully invested the whole way, your returns were robust—an annualized 8.81%.

But here’s the kicker: miss just the 10 best days out of those 3,700-plus trading days, and your return is more than halved. Miss 20? Suddenly, you’re looking at a loss instead of a gain.

In other words, the market’s most rewarding days are rare and unpredictable—blink, and you might miss them. And those missed days are precisely the difference between compounding your wealth or falling frustratingly short. This is why the stakes for getting in and out of the market at just the “right” moment are so impossibly high.

Simply put, capturing these rare, big-up days is critical—and the only reliable way to do that is to remain invested, even when headlines tempt you to the sidelines. Trying to outguess the market doesn’t just risk missing out; it practically guarantees it.

Why Are Market Highs and Lows So Tightly Packed Together?

Now, you might wonder—why do the market’s best and worst days seem to huddle together, like siblings sharing the same bunk bed during a thunderstorm? It turns out, volatility has a habit of clustering. When uncertainty is high and headlines are relentless, market swings—both up and down—tend to follow each other in rapid-fire succession.

A study by J.P. Morgan found that, between 1999 and 2018, many of the strongest rebound days landed squarely amidst the worst declines, sometimes within mere days or even hours. During these tumultuous stretches, market timers often find themselves nervously sitting on the sidelines. Meanwhile, the markets can bounce back with exceptional speed: research covering downturns since the late 1920s shows an average return exceeding 20% in just the three months after a major drop.

Here’s the catch: missing even a handful of these pivotal recovery days can dramatically reduce long-term returns. Unfortunately, because the best days are typically right next to—or even tangled up with—the worst, stepping out in fear of losses often means missing out on the subsequent gains.

This is the conundrum that makes market timing such a slippery slope. Or as financial journalist Jane Bryant Quinn wryly put it, “The market timer’s Hall of Fame is an empty room.” The real risk isn’t simply being wrong about when to get out; it’s failing to get back in at just the right moment—because the market rarely hands out invitations in advance.

The Hidden Costs of Market Timing

Let’s also not overlook an often-ignored pitfall: the toll market timing can take on your wallet. Every attempt to dart in and out of the market—chasing headlines or gut feelings—brings with it a parade of transaction fees and, all too often, extra taxes. Each buy or sell might seem harmless in the moment, but those brokerage commissions and potential short-term capital gains have a way of quietly siphoning value from your investments over time.

Contrast this with a buy-and-hold approach, where trading activity is minimal. By staying the course, you sidestep a significant chunk of these costs, letting your investments do what they do best: grow, compound, and—hopefully—prosper in peace. In other words, patience isn’t just a virtue; it’s a strategy.

Bull vs. Bear Markets: How Do They Stack Up?

It’s natural to wonder just how bull and bear markets actually measure up against each other. Dig into the numbers, and the story is clear: bull markets generally show up to the party more often, stay longer, and are much more rewarding than their bearish counterparts.

Frequency & Duration: Since 1942, we’ve seen an almost even mix of bear and bull markets—15 of each according to an analysis from Morningstar and Bloomberg. But that’s where the similarities end. On average, bull markets have a much longer lifespan, sticking around for about 4.4 years, while bear markets typically last less than a year.
Magnitude: When stocks tumble in a bear market, the average pullback is around 31%. Compare that to the typical gains of a bull market, which soar to about 156%. Not only do bulls run longer—they run much, much farther.

So if you’re tempted to try hopping in and out of markets based on short-term forecasts, keep this history in mind. Missing the upswings to avoid the downturns can do more harm than good—especially when the gains from bull markets so handily outpace the losses suffered during bears. Staying invested has simply outperformed the alternative time and again.

Stranger Things

So, are we predicting a happily-ever-after for 2022? Hardly. Then again, you never know; stranger things have happened. 

Instead, because we don’t know, we diversify. And we wait. Since markets have been rewarding evidence-based investors through the decades for this level of patience, we intend to continue doing the same. Let us know if we can help you manage an investment portfolio ideally structured to sustain you, your family, and your wealth through the perpetual uncertainty that lies ahead.