The Costs of Market Timing | AWM Insights #116
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Episode Summary
Can you trade on the market inefficiencies and come out ahead after costs and taxes?
The evidence is clear and it isn’t good news for the market timers. These market timers are investors and advisors that promise to get out at the top and then get back in at the bottom. It sounds great in theory, but because the public markets are so efficient, the evidence is clear that it isn’t possible over the long run. Many investors have poor investment experiences because they try to accomplish the impossible rather than focusing on the things that they can control.
Jumping in and out of the market is a fool’s game and that shouldn’t be thought of as a negative at all. It’s an opportunity to reframe and focus on what you can control when it comes to investing. This includes tax efficiency and minimizing costs, but also goes deeper into diversification and properly protecting your financial house from uncertainty.
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Episode Highlights
(0:28) Athletes at the highest level know they are playing the game at a different level than the amateurs. This is the same in the investing world.
(1:10) Not trying to outguess or time the market. Don’t outsmart yourself here.
(1:29) Eugene Fama. famous for the efficient market hypothesis. famously quipped “I’d compare stock pickers to astrologers but I don’t want to bad mouth the astrologers.”
(2:15) The outright number of competitors playing the “investing game” are intelligent and skilled adversaries with everyone on a level playing field of information.
(3:21) Markets are not perfectly efficient, but it is the best model to explain what is happening that has been created so far.
(3:30) Can you actually trade or invest on market anomalies and come out ahead? The answer in the data is no. Not when you factor in the costs and taxes.
(4:30) A great question commonly asked is “where is the market going?” No one has a crystal ball to answer this question and if somehow they could accurately predict the market, they would be making money off of it and not divulging their secret power.
(5:00) Going to the evidence proves over and over again that it is a fool’s game.
(5:42) The cost of missing one week in the market at the wrong time can cost you as much as 15%.
(6:48) If you jumped out of the market during the global credit crisis, which many did amidst the uncertainty, missing just 6 months was a massive cost in lost wealth.
(7:31) The positive of all this is the fact that market returns are actually very good. Getting those expected returns and focusing on improving them with tax efficiency and reductions in the costs that erode returns is a good use effort.
(8:04) Missing out on the factors that improve performance combined with the power of compounding can factor into leaving massive amounts of your wealth on the table.
(8:34) Market timing can be extrapolated out to emerging markets or real estate. Are you costing yourself by not being in certain markets?
(9:03) If you got a 20% return, is that good? Well, what did the market do? You may have cost yourself money because another market did even better than that.
(9:30) When market timing, you have to be right when you get out and then also when you get back in. You can play this same game across all markets.
(10:25) You have to be right at the outset, then you have to guess how long it will last. Then you have to be right when getting back in and to what market. If you get any of these decisions wrong you have created a massive cost to yourself.
(12:30) You still want to participate and buy good companies. Right-sizing the investment is the key to avoiding when to get in and when to get out.
(13:40) In March of 2020, few people predicted the market would recover so quickly with tech outperforming. Then the dynamic changed in late 2021 with tech crashing and underperforming.
(14:50) If you missed the 3 months of the COVID crash by pulling out all your money before the decline. You actually would have missed out on 30% of gains by being right about a global pandemic.
(15:22) It sounds good to avoid the losses and get out and then get back in but playing this game will cost you money in the long run.
(15:30) If you want a better investment experience turn your focus to what you can control. Don’t try to outguess the market and don’t chase performance. A data-driven investing experience lets markets work for you and grow your wealth. Don’t get in the way or let your broker get in the way. The capital markets have done this for over a hundred years.
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+ Read the Transcript
Brandon Averill (00:06): Well, Justin, we're back for another one. We're going to keep on this series here. We're just talking about trying not to be negative. Nancy's on all these episodes. So hopefully everybody's taking away the good lesson here is we're not really trying to be negative, but what we are really trying to do is help you to have a better investment experience and just show you a different way for those of you that are athletes, you know that when you're playing at the highest level, oftentimes you're playing a different game than the amateurs. And so we want to bring that to your investment experience. And so last week we really hit on resisting, chasing that past performance. It's natural to think that's an indicator. And so we wanted to spend a little time just talking about why it isn't and getting to the data, because ultimately we don't want to rely upon just our opinions, but we want to go back to the facts and really dispel some of the common sense or that you would think about investing and look for that better way.
Brandon Averill (01:03): And so this week we're going to continue down that train. Justin will keep with these themes here. And what we're going to talk about today is not trying to outguess the market or time the market, trying not to be too smart here. Right? Go back to the data. And let's just continue this discussion here about playing a different game. So we'll kick it off. You actually found this quote, but I'm going to steal your thunder because I thought it was too fantastic. But Eugene Fama-
Justin Dyer (01:28): That's all right.
Brandon Averill (01:29): Yeah, won the Nobel prize for the efficient market. I hypothesis has the best quote I've seen and it's, I'd compare stock pickers to astrologers, but I don't want to badmouth the astrologers. I think that's all you need to hear folks, but we'll unpack it a little bit more. So Justin, maybe jump in there and let's just talk a little bit about outguessing, trying to outguess the market. Why is that a fool's game?
Justin Dyer (01:53): Yeah, it goes a lot to what? Back to a lot of what we discussed I think at the first episode of this series. So what is that? Three, four episodes back where we talk a lot about the efficiency of the market and just to set that table again, think about that where there are so many competitors coming to the playing field, if you will or what we're talking about here is the market. And again, quick clarification, we're talking about the public markets in this conversation and just the outright number of individuals who are coming to play this investing game. Obviously it's not a game. It's a very serious thing when it comes to people's hard-earned savings and whatnot, but for these conversations, we'll use that simple analogy and these are incredibly intelligent, incredibly skilled people.
Justin Dyer (02:43): And then even more importantly almost, or definitely something not to be left out of this conversation of the equation is the fact that they're all playing with the same information.
Brandon Averill (02:55): Right.
Justin Dyer (02:56): The rules of the playing field are consistent. We know exactly how much the ball is inflated and how player X, Y, Z is feeling that day or whatever the case may be. Maybe I'm stretching these analogies a little bit, but it really goes back to this idea of market efficiency. And while the market isn't perfectly efficient, we did touch on this, it's the best model that is out there to explain how markets work. There are weird anomalies that happen in the marketplace from time to time. But then the question has to become, can you actually trade on that information? Can you invest on that information on an after cost, after tax basis and still come out ahead? And really at the end of the day, the answer is no, because of this idea of efficiency really at the end of the day.
Brandon Averill (03:51): Yeah. And there's been study after study, right? There's a famous work, Burton Malkiel wrote A Random Walk Down Wall Street. And I think he uses the example in there, right of the monkey, the blindfolded monkey throwing darts and having better performance than these professional stock pickers. And that data just continues to come out time and time again. And we want to think that we can bring a certain skill level to that picking individual equities game. And unfortunately it just doesn't show up. And so as we move beyond that, I think that's a pretty well-established thing that we've hit on now. It turns to market timing. We get this question oftentimes, what do you think? Where's the market going?
Justin Dyer (04:34): Great question right now.
Brandon Averill (04:35): Yeah. It is a great question right now. It's fascinating. And I think the quick response is always like, "Hey, if we had the crystal ball, we probably have a few clients and we'd be doing something else, because we'd been making a ton of money". But I say that tongue in cheek, but it's kind of true, if you really think you can predict the market, that's just an incredible thing to believe that you actually could do. And when we go back to the data, we go back to the evidence. It again, just continues to show up that it's a fools game and even more than a fools game, it doesn't just maybe cost you a little bit of performance here or there. I mean it can be disastrous.
Justin Dyer (05:12): It can.
Brandon Averill (05:12): Right?
Justin Dyer (05:13): Yeah.
Brandon Averill (05:13): I mean, if you want to... Some of the examples we pulled up, I know we both have them here are pretty striking.
Brandon Averill (05:21): In fact, I mean, you look at some of this data here if, I thought this was fascinating, just bringing this up. This is again back to timing the market and what some of the cost could be. But the study goes back over a 25 year period from 97 to 2021. If you just would've taken a thousand dollars and you would've allowed the Russell 3000, so 3000 companies in the U.S. to grow, it would've returned you about a little over $10,000, $10,300 to be specific, somewhere in that range. If you would've just missed one week and that week happened to be in November of 2008, so emotions are riding high, people are pulling their money out. It's hard to be invested at that point. So if you pulled your money out, your return goes down to $8,600. That costs you about 14, $1,500 in performance.
Brandon Averill (06:19): That's massive, right? That's 15%. We start to look out further time periods. It starts to cost you even more. If you would've missed the six month period ending September 4th of 2009, so let's think about this, 2008 is the global credit crisis, blood is in the streets, people are losing their jobs, people are losing their homes, etc. Totally natural to want to be out of the market at that point. But if you were only out for that six months, now your $10,300 goes down to 6,700. I mean, dramatic if you have that impact. So trying to figure out when to get in, when to get out, it's hard, but if you miss, you miss big.
Justin Dyer (07:02): Yeah, you really do. And it gets back to just looking at the data and we say, I think we've wrapped most of these podcast over the last couple episodes, focusing on controlling what you can control. That's where we start to reframe this as kind of the more from a positive standpoint, this isn't all negative and saying, "Hey, it's silly to pick stocks or don't try it out, guess the market, etc., etc." It's to say all that because that's the common belief, but it's then, lets reframe this to say, "Actually, well, those returns you just highlighted are really, really good." So we want to make sure we're at least getting those returns. And then what can we do to add to that as well? Right? We think about tax efficiency, keeping cost low. All these other things that we've talked about. And we'll probably dig into more and more.
Justin Dyer (07:50): But that's really the reframing of the game that we're trying to play, where the common discourse or the common themes are really just surface level at the end of the day. And you're missing out on these additional cost, these additional factors that really do end up dragging on your performance significantly. I mean, would you say 15% there? That is substantial. And then think about that compounded over many, many, many years of time, you are leaving substantial wealth on the table.
Brandon Averill (08:24): Yeah. I mean, it's absolutely dramatic and kind of going back, that's timing when to get out of the entire market, right? And it gets even extrapolated out when you have this belief that now you can go find an individual stock or maybe you're going to only invest in certain parts of the market.
Justin Dyer (08:43): Right.
Brandon Averill (08:43): We hear about this all the time. Why would we be in emerging markets or why would we be in the U.S. right now? Or shouldn't we just take all our money and put in real estate? And it's so hard because we'll hear this time and time again where, "Oh, we got to call it a 20% return in real estate. Is that good?" Most people don't even know if that's good. A lot of times you underperform the market. And so that 20% return might sound really good, but did you cost yourself because you were out of another market, right?
Justin Dyer (09:16): Right.
Brandon Averill (09:17): So you start getting all these potential timing, decisions wrong, and we've hit it time and time again but you have to get a few decisions right to be able to even benefit from this and think about that. Right? You're not just getting the decision right of when to get out, but then you got to figure out when to get back in or you got to figure out when to get back in and when to get back out. There's a lot of decisions at play to get this right.
Justin Dyer (09:41): Oh yeah. Yeah. I mean, just think about it. Right now we're going through a correction or, and in some markets you've hit quote unquote bear territory, which is a 20% decline from the peak. Over the last what? Two years there's probably been, I mean, goodness gracious, we could probably find hundreds of commentary within the financial process as, "Oh, the bear market is going to start today or we're going to have a correction any day now, etc., etc." We often, unfortunately don't go back to actually qualify what those people have said and gauge them and judge them on the accuracy of their call. But that's another critical aspect when you have to get it right at the outset, and then to your point, you have to guess how long it's going to last.
Justin Dyer (10:30): Is this the bottom? Is now the time to get in? It's not just these simple, "Oh, we're at the peak of the market. I'm going to sell out." Right? First of all, that's incredibly difficult to get on its own. And then you add all these additional guesses or predictions that you have to get right. And it becomes really, really foolish especially when you look at the data around the cost at getting them wrong. I mean, it just really proves the belief or our statement here that not playing this game, playing a different game is really how you build multi-generational wealth, how you sustain and earn a very, very handsome rate of return over the long term or you should earn a handsome rate of return, got to qualify everything. You should earn a handsome rate of return over the very long, long term.
Brandon Averill (11:23): Yeah. I think that's a fantastic point. And I think even going back to some of the data even around, there's a lot of, we're just talking about this large companies, for instance, you're becoming part of the S&P 500. I think there's an example of Intel where the five years leading up until joined the S&P 500, the annualized return was something like 29%, the five years after that, it underperformed the entire market by 6% annualized. Still had a positive return so you may be sitting there, you got 29% a year up until it joined the market, or joins the S&P 500, then all of a sudden it joins and still has a positive return. You think it's going well, but it's actually trailing the market by 6%.
Brandon Averill (12:11): And so what we're saying is not to invest in Intel, we're saying to right size it, to invest in everything. Right? So you still get the participation. I think that's another nuance maybe to talk about here a little bit is what we're not saying is just a, you still want all of these companies' portfolio, right? We're not suggesting your kind of what we're talking about, timing in and out. You're going to hold everything. You're going to participate. Let the capital markets work for you.
Justin Dyer (12:39): Totally. Yep. I think that's a great comment. And I would also highlight it to the recent history. I mean, the last two years that we've just been through, starting with the pandemic, it is such an incredible microcosm of everything we're talking about. So you have kind of piggybacking on what you were just saying, you have this large company effect if you will, where the big tech names really performed quite well coming out of the pandemic or through the pandemic rather. And that has shifted as of late, quite significantly, especially in 2022, which is when we're recording this, the big high flyers within the tech space specifically. I mean, a lot of high flyers have come off quite a bit. Crypto being a big one as well. You're seeing exactly what you're highlighting.
Justin Dyer (13:30): This is a short period of time, who knows what the future will predict, but guessing... So let's just go back to what I was just saying. March of 2020, when the COVID crash happened. Very few people were predicting that the market would've rebounded the way it did, the fed responded the way it did. Then growth stocks, tech specifically took off like a rocket ship, brought the market as a whole along with it. But tech really did outperform and then fast forward to kind of end back half of last year, that dynamic changed and has changed pretty drastically as well.
Justin Dyer (14:03): So it just gets back to this exactly what we're talking about. This recent period of time, we're actually pretty fortunate to be living through because it really, in my opinion, underscores a lot of these examples, these tenants that we're talking about here and what actually results in a good investing experience overall, and being disciplined and keeping cost low and not chasing performance, etc., etc. I think all of those things have proven to be incredibly true over the last, I mean, they're proven to be true over the long term, but even within the last 24 to 36 months, most definitely.
Brandon Averill (14:40): Yeah. And I think it's funny, you just brought up the COVID crash because I didn't cite it, but that's the other bar. If you missed the three months of the COVID crash, so if you pulled all your money out, let's say you actually timed it pretty well and you caught it at the beginning of the decline and you held out and you left and missed that three months ending the June 22nd, 2020, your $10,300 became $7,300. So 30% impact by pulling your money out and panicking potentially, or just thinking like, "Hey, I'm going to get ahead of this. I'm not going to catch the falling knife. I'll get out, I'll get back in." Right? You're going to cost yourself quite a bit of performance there. And so I think in summary, what we got to go back to is the stuff that we've been hitting on the head multiple times throughout this series and really over the last years, controlling what you can control like you said.
Brandon Averill (15:34): Let's not try to play the game of getting in and getting out, chasing that performance, like we talked about last week or trying to outguess which way the market's going to go or which way a company is going to go from a performance standpoint. Let's not try to time the market. Let's really start to have a better investment experience. Let's go back to the data. Next week, what we're going to probably hit on is that concept that we just talked about. Let markets actually work for you. Give them a chance to grow your wealth. Don't you get in the way. Don't let your investment advisor get in the way. Oftentimes this is how they try to justify the value. If you're with one of these big brokers that is almost guaranteed, what they're trying to do, don't let them get in the way of that.
Brandon Averill (16:19): Understand that you want the capital markets to grow your wealth in the way that they have for over a hundred years. Right? And we want to participate in that. We don't want to get in the way of that. So we're going to close out here for this week. But before we do, mention it a few times, shoot us a text. We want to hear from you. That number is 602-7O4-5574. We'd love to answer your questions around these topics as we've talked about in previous episodes. So shoot us a note there. And until next time. Own your wealth, make an impact and always be a pro.