Why the Fool Doesn't Recommend "Market Timing" as a Strategy -- Even Now

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In this segment from the MarketFoolery podcast, host Chris Hill and Motley Fool Total Income's Ron Gross consider a common question of investing philosophy, posed this time by a podcast listener: Why doesn't the Fool recommend trying to time the market, especially now, when the signs that stocks are going to drop just keep getting clearer?

The answer, in a nutshell, is that no matter how good you are at guessing when to buy or sell, you're not as good as you think. Some folks may get lucky. (Statistically, that's inevitable: In a large enough group, some people will guess right a few times in a row.) But it's much, much easier to be wrong, and here are the numbers and details to prove it.

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A full transcript follows the video.

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This video was recorded on April 3, 2018.

Chris Hill: We got a question in our Facebook group from Avi in Folsom, California, who writes, "I'm wondering if The Motley Fool team can do a segment on why it's better to hold long-term than to try to time the market. There's a lot of indicators that the market correction is looming, like Warren Buffett and Charlie Munger sitting on cash, rising interest rates, etc." I find it interesting that Avi is looking at these different things and concluding that a market correction is coming. But, then again, if that's the case, he's not alone, there are plenty of people, just turn on financial television.

Ron Gross: We're down 10%, aren't we?

Hill: Yes. Although, our co-founder David Gardner and others, including myself, take issue with the term "correction" defined as a drop of 10%, as though a rise of 10% is incorrect. Anyway, in terms of the basic question of holding long-term vs. timing the market?

Gross: You want to time, you really do. I think institutional portfolio managers want to time, everyday retail investors and Fools want to time. But honestly, I think you're better off not, even though sure, there's probably some folks who have had success doing it, and they're the folks who write a book or you hear about on CNBC. But for the most part, most of us can't do it. And the reason is, first of all, it takes an incredible amount of attention. You have to be very hyper focused on not only your portfolio, but the markets. Most everyday investors are not that hyper focused on it. They don't have the time or the desire to be that focused on it.

But, even if you do have the time, it's still incredibly difficult. I love an article that I saw from Forbes, which said, "Successful market timing requires two correct decisions: when to get out and then when to get back in. Guessing right once is a 50-50 proposition. Guessing right twice drops the odds to only 25%." There are so many times where I have said, "All the Shiller indications, the Berkshire, the anecdotal, it looks like the market is overvalued, time to get out." Then, do you know what happens? The market has another 20% up year. It's very, very difficult.

The reason I brought all this paper [shuffles papers] is because there's a study I wanted to tell Fools about that I thought was really interesting. If you had invested in 1996, by the end of 2016 you would have had an annualized return of about 8.2%. If you missed the best five days of that period, your return would have dropped to 6%, significantly underperforming the market. And if you missed the top 30 days, you actually would have lost money. So, it really ups the ante here --

Hill: By the way, just to emphasize, over a 20-year period.

Gross: Right. Just five days over a 20-year period makes such a difference. And let's face it, you're going to miss some of those days if you're trying to time. And selling a portion or all of your entire portfolio, it could take not only time, but could also be quite costly and terms of capital gains that you'll be forced to pay for all the investments that you hold in a non-tax-advantaged account. So, if you don't factor in the cost of capital gains, you're not doing the math appropriately, either.

So, it's tempting, I get it. There are times where I'm heavier in cash than not based on whether I can find investments easily or not. I think that's OK, and I think selling stocks when you think their upside is limited is OK. But, to be a real market-timer, I think, is fraught with issues that will probably, in almost all circumstances, end up not turning out well.

Hill: The only thing I'll add is, Warren Buffett and Charlie Munger have been sitting on piles of cash for years.

Gross: A very long time.

Hill: I've stopped counting the number of times that Buffett has come out and given an interview on CNBC and said, "Boy, the elephant gun is loaded, I'm ready to buy something, but I just don't see anything cheap enough."

Gross: And if you're going to be a market timer, that's the better kind to be. He's not selling stocks, he's just not putting new cash to work because he can't find something that he likes enough. If you're going to have to be a market timer, that's the kind to be.

Chris Hill has no position in any of the stocks mentioned. Ron Gross owns shares of Berkshire Hathaway (B shares). The Motley Fool owns shares of and recommends Berkshire Hathaway (B shares). The Motley Fool has a disclosure policy.