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Why is it so Hard for Investors to Believe Time in the Market, Not Market Timing, is Better?
Investing in the stock market is often seen as a blend of art and science, where strategies and philosophies abound. Among these, one of the most debated topics is whether investors should focus on “time in the market” or “market timing.” Despite extensive evidence supporting the former, many investors still find it challenging to embrace this approach. Let’s explore why this is the case.
The Allure of Market Timing
Market timing refers to the strategy of making buy or sell decisions of financial assets by attempting to predict future market price movements. The allure of market timing is understandable: it promises the potential to buy low and sell high, maximizing profits and minimizing losses. This notion is compelling, especially in a culture that values immediate results and quick success. Social Media, CNBC, and stock market tickers on nearly every financial website subliminally reinforce that maybe we too, can time the market. The idea that one can “outsmart” the market and achieve extraordinary returns is deeply attractive, often overshadowing the more mundane, patient strategy of staying invested over the long haul.
Psychological Biases
Human psychology plays a significant role in why investors gravitate toward market timing. Cognitive biases, such as overconfidence and the illusion of control, make us believe we can predict market movements accurately. Overconfidence leads investors to overestimate their knowledge and ability to predict market trends, while the illusion of control makes them think they have more influence over events than they actually do. These biases drive the belief that market timing can be a reliable strategy, despite evidence to the contrary.
Media Influence
The financial media often exacerbates this problem. Headlines frequently highlight spectacular gains from short-term trades and sensationalize market movements, fostering a sense of urgency and the idea that one must act quickly to capitalize on opportunities. This constant barrage of information and the focus on short-term results can mislead investors into thinking that market timing is the key to success. In reality, the media’s focus on immediate results overshadows the benefits of a long-term, steady investment strategy.
The Nature of Market Volatility
Market volatility can be unnerving. Sharp declines, corrections, and bear markets can make the prospect of staying invested seem risky and counterintuitive. The natural reaction to market downturns is often to pull out investments to prevent further losses, driven by fear and a desire to protect one’s capital. This behavior contradicts the principle of time in the market, which emphasizes staying invested through ups and downs to benefit from long-term growth.
Evidence Supporting Time in the Market
Despite these challenges, empirical evidence overwhelmingly supports the principle of time in the market over market timing. Numerous studies have shown that long-term investors tend to outperform those who frequently trade based on market predictions. For example, a study by Vanguard found that the average investor significantly underperforms the market due to the negative impact of frequent trading and attempts to time the market. The costs associated with frequent buying and selling, such as transaction fees and taxes, further erode returns.
The Importance of Patience and Discipline
Successful long-term investing requires patience and discipline, virtues that are often in short supply in our fast-paced, results-driven society. The concept of compound interest underscores the importance of time in the market. By staying invested, investors allow their money to grow exponentially over time, benefiting from the reinvestment of earnings. This slow but steady approach is less glamorous but far more effective in building wealth.
One of the most valuable benefits of having a financial advisor is to educate investors and dissuade them from imprudent actions like market timing. Most advisors can point an investor to many quality research papers proving out that time in the market trumps all other strategies. In addition, the advisor is there to be the voice of reason in times of tumult, including market melt-downs, market melt-ups or political strife or other events that can push an investor to rash action.
Related: Human Advice Prevails: Understanding the Evolution of Robo-Advisors