Breadth Thrusts & Bread Crusts: Market Timing Is Hard

JC Parets
May 12, 2022

From the desk of Willie Delwiche.

Volatility is on the rise and some of the reactions we’re seeing are entirely predictable.

For instance, I’ve seen multiple versions of this chart shared in recent weeks:

It claims to show how hard it is to effectively time the market. Advisors and strategists use this to scare investors with a seemingly straightforward message: If you miss just a handful of the best days in the market, your returns will suffer.

The arithmetic is correct. Take out the 50 best single days for the S&P 500 since 1990 and the index has gone nowhere. 

At the same time that market timing is described as hard, the illustration assumes a degree of pinpoint accuracy – that an investor misses only the best days and nothing else. That seems unlikely. But if we are going to be shown what it looks like if only the best days are missed, it seems only fair to also consider what happens if only the worst days are missed. 

In the same way that missing only the best days quickly eats into returns, missing only the worst days dramatically boosts returns.

Neither of these scenarios is likely. Properly anticipating the degree and direction of day-to-day fluctuations in the market is beyond challenging. 

What’s more reasonable is the realization that the best days and the worst days tend to happen in close proximity, clustering in periods of heightened volatility. The effect of avoiding an equal number of the best days and worst days might be startling: portfolio returns rise and standard deviation falls. Moving to the sidelines in periods of market volatility increases returns and reduces risk.

Some are fond of saying that volatility is the price of admission investors need to pay to get access to the market’s returns. It seems to me that volatility is a tax – a financial and psychological burden we should minimize when possible. 

That’s why we spend so much energy trying to identify the market environment. We’re not trying to time day-to-day swings. Instead, we’re trying to smooth out volatility and manage risk. Our goal is to survive bear markets so we can thrive in bull markets. We want to preserve financial and emotional capital now so we can effectively put it to work when the odds of success increase. The volatility roller coaster is expensive and is not something I want to ride.    

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