Best of Frank: Why Market Timing is Hard

[I'm off this week, enjoying the waning days of summer and catching up on a few things I promised to finish before September. In the meantime, please enjoy this example of that great American summer tradition, reruns. This post originally ran April 7, 2009.]


Not long after you convince yourself that buy-and-hold is the best way to invest in the stock market, you start to get doubts.  Sure, owning a well diversified portfolio of stocks through thick and thin is the best way to capture the high long-term average returns that you expect, but couldn’t you do a little better?  Couldn’t you sell your stocks when the market is particularly high and maybe double down when it is particularly cheap?  How hard could that be?

image Pretty darn hard, it turns out.  Only in the clarity of hindsight are those market peaks and bottoms obvious.  The towering heights that the market reached in the spring of 2000 and fall of 2007 now look like great places to exit only because we know what happened next.  Yes, stocks in 2000 were by many measures more expensive than they had ever been in the past, but saying that everybody should have therefore known to sell is unfair, because stocks had been unprecedentedly expensive in each of the four or five years prior to 2000 as well.

Spotting the low points when they happen is no easier.  After its disastrous September, the market was by many objective measures very cheap in the fourth quarter of last year.  And then it went down a lot more.

But even if you did have a useful objective measure that would tell you when the market was too expensive or cheap, actually using it would be a lot harder than it sounds in the abstract.  See that dip on the chart above in early March?  That’s when the market hit its low for the year so far.  It is also when I published this post, making the strong case that the market was then really cheap.  Since that day the S&P is up about 25%.

Did I act on my judgment that the market was a bargain, invest big and reap a much needed profit?  Are you kidding?  Read the post again.  I had thought it was too cheap months before, only to watch it get more cheap every week. I didn’t understand why it had gotten so low, and so had no reason to believe it wouldn’t go lower.

When I was just starting out in the professional investing world, one of the senior guys in the office took me aside and said something like “Frank, what you gotta understand about the market is that it’s really all psychology.”  This guy made roughly a hundred times as much money as I did, so I nodded and smiled, all the while thinking to myself something like “what a pompous and empty platitude.”  It only took me about ten years to understand the wisdom he was trying to pass on to me.  It’s not just that stock  prices move up and down because of the irrational behavior of other investors.  It’s that making money in the market is hard because of your own irrational behavior.

It has been said that the four most dangerous words in investing are “this time is different.”  When the market is very cheap it is nearly impossible to convince yourself that it is a good time to buy, even if in hindsight every other time it was that cheap it had been a great time to buy.  Because when push comes to shove you are sure that this time is different.  You worry that this time the world really is coming to an end, that capitalism is dead, and that your kids better start studying Chinese if they ever want to get a job.  Then the market goes up, the dust settles, and you feel like an idiot.

That it is very difficult to buy at the bottom and sell at the top is not mere coincidence.  You are just like everybody else, irrationally scared at the lows and foolishly confident at the highs.  Widespread fear and confidence is why the market was low and high to begin with.

Which is why you should cast away your doubts about buy-and-hold.

No Comments

  • By Kosmo @ The Casual Observer, August 27, 2009 @ 10:00 am

    I fully agree. If stockbrokers can have difficulty timing the market, why would I, as a layman, be any better?

  • By Rob Bennett, August 28, 2009 @ 8:49 am

    Rob Arnott recently described today’s conventional investing wisdom as the product of “myth and urban legend.” This is the sort of thing that he was talking about.

    There is of course nothing even a tiny bit “hard” about timing the market. To time the market means to change your allocation so that you get a better long-term return than you would have obtained by keeping your allocation constant. The “hard” part is figuring out that stocks offer a better long-term value proposition when they are selling for reasonable prices than they do when they are selling at insanely dangerous prices (just as is so with anything else on Planet Earth than can be bought or sold). Come to understand that basic reality, and you will do better than those investing passively. Or at least so our common sense informs us and so the entire historical record confirms for us is so.

    Is it “hard” to understand that the price you pay for stocks affects the value proposition you obtain from buying them? There is one sense in which it is. The Stock Selling Industry thinks it is just wonderful if people do not take price into consideration when buying what they have to sell. So if you take their marketing slogans (“Timing Never Works”) seriously, then, yes, market timing becomes an incredibly complicated and an incredibly difficult thing to pull off.

    If you tune out the marketing junk, successful timing is as easy as pie. You buy lots of stocks when they are selling at good prices, you stay away from stocks when they are selling at insanely dangerous prices (as they were from 1996 through 2008). It has always worked. It always will work. It is not even possible for the rational human mind to imagine circumstances in which it will not work.

    Market timing is not hard except for those who elect to make it hard by investing their retirement money pursuant to “ideas” they hear repeated over and over again in marketing slogans.


  • By Josh Yeager, August 28, 2009 @ 11:52 am

    Rob, how do you tell when stocks (for example) are overpriced? Sure, you can say in retrospect that there were two bubbles between 1996 and 2008, and you could probably have known at the end of 1999 that tech stocks were vastly overpriced. But when you’re halfway into the “up” side of a bubble, it doesn’t look like a bubble. It just looks like you’re getting better-than-average returns. I think that’s Frank’s point.

  • By Rob Bennett, August 28, 2009 @ 3:54 pm

    Rob, how do you tell when stocks (for example) are overpriced?

    I look at the P/E10 value, Josh. That’s the price of a broad index over the average of the past 10 years of earnings. If you do a regression analysis of the historical data, knowing the P/E10 value that applies on the day you buy a broad index makes the price that will apply in 20 years 78 percent predictable. Stocks are not a risky asset class if you are willing to take price into consideration. All of the “excitement” of owning this asset class comes from the idea that it is better not to consider price when setting your stock allocation.

    The P/E10 value was above 25 for virtually the entire time-period from 1996 through 2008. We have been above 25 four times in U.S. history. The average price drop seen on those four occasions is 68 percent. We have never seen a price drop of that size starting from a time when stocks were selling at reasonable prices.

    Investors who are willing to take price into consideration when setting their stock allocation can realistically expect to be able to retire five years sooner, according to the historical data. That’s how big a difference it makes to be open to considering price (something The Stock-Selling Industry very much does not want us to do).

    Timing works.


  • By Retirement Savior, August 29, 2009 @ 11:44 pm

    Rob, I agree with you about timing and buying value. It’s too bad that the great majority of people have an emotional reward system that is short term, with a dollop of recency bias thrown in.

    I would argue that the advisor/broker industry is too inundated with the MPT/EMH doctrines, where market returns fall along a normal distribution. If that ever ends (not during our lifetimes), I think you would see value and timing re-enter the industry.

  • By Shogun @ Financial Samurai, September 1, 2009 @ 4:55 pm

    Hey Frank – I think we have a kindship! Do you need to work btw if you’ve been a HF manager for so long?

    Market timing is hard in the long run, but in the short run, anything goes. I wrote about this on Aug 31st to get out of equities.

    Come visit me at Financial Samurai. I think you will get a kick out of it.


  • By Geoff, September 4, 2009 @ 11:46 am

    There appears to be mass confusion about what market timing is and what it isn’t. What you need to understand is that financial planners have the market timing mentality weeded out of them during training because they couldn’t possibly support all their customers moving funds frequently – they’d be too busy! It’s not that it can’t be done, it’s just that the financial community wants you to believe it can’t be done. The second biggest issue is that most people believe that market timing is catching the extreme tops and bottoms of the market. That’s nonsense. You can’t do that. But what is extremely easy to do is be on the right side of the market when meaningful trends are in place. Don’t believe me? Just go to and see how you could EASILY have sat out of the last several years loss of equity value – and also been able to be back in for the latest move up!

  • By Neville Sampsel, August 2, 2013 @ 7:32 am

    I am a keen letter writer, and would really like to know if there is anyway of creating a letter writing community through this. Creative letter writers writing to creative letter writers the entire world over. I’ll reply to all those who wish to write and not just receive. 51 Lavender Sweep, London SW11 1DY. England

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  1. Weakonomics Links: The Next Financial Crisis? | Weakonomi¢s — August 28, 2009 @ 11:04 am

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