5 Reasons Why Market Timing is Controversial
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A lot of investors consider the market to be their ally, while others think of it critically. Market timing is one concept that has led to the emergence of two different schools of thought that are pro-market and anti-market. While the controversy lies right in the perspective that investors have for financial markets, the investors are either market-timers or prefer to buy and hold their investments.
Market timing is a highly debated topic across the industry. Investing is not only about returns but also involves considering all the aspects and consequences related to the investment tool. Since the markets work in cyclic movements, it is extremely necessary to have a general idea of the current and upcoming phases. But the trouble starts when investors make specific predictions regarding market-related instruments based on these cycles. Some investors also refer to market timing as gambling, as it includes a fair deal of taking calculated risks which may or may not prove favourable to your financial health. This makes market timing a highly controversial subject.
Here are 5 reasons why timing the market can be a moot exercise:
1. You might end up paying more than you make
When you rely highly on timing the market to earn profits out of your investments, you are committing to a full-time job that will require you to stay active at all times throughout your investment horizon. An active investor may have to trade weekly, monthly, and if required daily. This will include buying and selling shares as per the market situation. This frequent trading can account for both commission or transaction charges and taxes. Now, if you did not consider taxes while making these trades, you might end up paying more than what you earn through them.
Hence, the risk of paying more than you make is one of the biggest reasons why anti-timing investors advocate buying and holding shares and letting compounding do its work over the investment period.
2. You may get crossed
Many people compare trading in the market to playing a game of cards. When you opt for an active investment style and believe in your abilities to time the market, you are still prone to get double-crossed by the vicious circle of market fluctuations. When you time the market, you have to be sure of two situations, one at the time of buying and the other at the time of selling. Hence, it would help if you had an idea of what cards your opponent – in this case, the market – holds.
Even if you manage to sell your shares at an attractive price, you have to be certain about buying the next ones in a fair deal. The real challenge will lie in striking the right chord in such dynamic trends in order to become a valued investor, at least when it comes to buying shares.
3. Long term gains may not seem so attractive
Timing the markets implies acting proactively in anticipation for the upcoming market phase. While it is next to impossible to actually predict what the next market movement is going to be, it is certain to create a moment of panic among investors, both market watchers and holders. The overall gains in the form of total returns can vary from investor to investor, which is decided based on how they reacted during earlier times of uncertainty and panic. According to various studies conducted over the years on investment behaviours, it is believed that the more exposure investors have had in equities, the more they panicked during all major market corrections. Many also ended up selling their equity shares at absurd prices that worsened their situation. This unplanned and impulsive act majorly affected their long-term goals and gains which could have otherwise been a better number to look at.
4. Market timing ignores a fundamental element of investing i.e. risk
Timing the markets wholly only focuses on the reward side of the investments. The one and the only aspect that is touched and worked upon are gains or returns, ignoring the other fundamental element of investing, such as risk. Market timers are only concerned about reaping huge benefits, irrespective of the risk involved in that asset class. But this approach works only until you keep getting returns. The moment the market starts behaving otherwise, investors may find themselves in a frenzy. Since the focus is majorly on high return instruments, the associated risk is also high. This leads to more significant losses in an unsupportive phase. A common trait that can be found in most market timers is that they rarely plan for an unfortunate event, ultimately skipping the need for devising an effective exit strategy. When the market hits hard, they have no backup plan and end up losing almost everything they banked on, including their faith in the market.
On the other hand, investors who play safe maintain a low key and have a robust exit strategy that they can count on it if the market goes down. Also, they factor in the risk and lay their investment portfolio in a way that hedges against the risk involved.
5. The viability is always in question
Market timing is a concept that is based largely on the luck of hitting a chance that holds only a 50% probability. In simpler words, your chances of making the right guess are only 50%, leaving the same space for a wrong assumption. This puts the success of your investment portfolio in jeopardy, bringing to question the viability of market timing.
Some market timing enthusiasts claim that market timing can prove to be highly efficient during an apparent high or low. Still, nobody can ever guarantee what surprises the market holds for investors.
To sum it up
As an investor, your primary aim is to generate higher returns from your investments, even if it includes buying and holding or timing the market. The effectiveness of your approach will depend upon how efficiently you manage and deploy it. This will involve factoring in all the essential elements such as like risk, investment horizon, liquidity concerns, etc. Keeping your investment in place with your life goals can serve as a guiding light in the right direction.
With high volatility and fluctuations in the market behaviour, timing the market has become all the more difficult over the past few years. It is advisable to seek some professional help from financial advisors rather than putting your investments at stake and letting the volatile markets confuse you.