Why timing the market is riskier than you think

Markets, predominantly stocks, have been on an incredibly strong run over the past couple of years which has led to positive performance across our portfolios, despite continued political and economic uncertainty. Given that markets work in cycles, seeing periods of strong growth and consequently retractions, there may be some thought as to whether any adjustments to your risk profile, or indeed a larger allocation to cash, need to be considered. 

However one of Moneyfarm’s key principles is that ‘timing the market’ and being reactive to potential future outcomes can be a costly strategy, with our recommended approach being to avoid this altogether if your goals remain the same. 

What is market timing?

Market timing is an investment strategy that aims to buy and sell investment securities to maximise returns. In practice, it involves trying to buy when prices are cheap and rising and selling when prices are at their peak and due to fall. However, market timing is not always a wise investment choice given the complexity and uncertainty with short-term outcomes.

This could be considered as holding too much cash in a current account, stopping regular contributions to investments during difficult periods, or disinvesting during a negative market phase – these are all unconscious forms of market timing (and even less controllable).

Why is it not a good idea?

The main problem with market timing is that it is extremely difficult to execute consistently. This is especially true for more extreme market tactics, such as moving most of your investment assets into cash to avoid a bear market or another significant market correction.

To successfully time the market, you have to be right twice. First, you need to choose the best time to disinvest, and second, you have to identify the optimal time to re-enter the market. Investment behaviour at this point is difficult to manage here too, as recency bias can heavily influence decision making. When markets are on the up, greed can play a factor as investors hope that the strong run continues, whereas in downturns fear can take hold which can obscure any potentially viable opportunities.

Timing the market is an incredibly difficult strategy because it requires getting two major decisions exactly right: when to exit and when to re-enter. This is no easy task, as emotions and cognitive biases often cloud judgment. For instance, recency bias can lead to overconfidence during market rallies, while fear can dominate during downturns, making it difficult to recognise potential opportunities. Rather than trying to predict short-term movements, a long-term, disciplined investment approach often proves to be more effective in navigating market fluctuations.

Knowing when the peaks and troughs will occur can be equally challenging and normally is only apparent with the grace of hindsight, as there are a few factors at play. For example, there can be contrasting signals suggesting markets are overvalued, with forward momentum carrying to greater heights than before over a prolonged period; or there are false alarms or a lot of sideways movement in the market so it’s hard to ascertain the difference between small pull backs and the start of a significant decline. 

The issue is that an error in timing entry and exit points can be very costly for investors. This is because the best market days often occur during the most challenging downturns, and missing even a single day can have dramatic consequences for long-term capital value. Having the correct exposure and capital allocation, therefore, is crucial for any long-term strategy.

The allocation of capital is crucial

Numerous studies have demonstrated that time in the market beats timing the market. For example, research conducted from famous economist Roger Ibbotson shows us (in a 10 year study detailed below) marketing timing accounted for 2% of return, whereas asset allocation was 91%. 

The portfolios managed by Moneyfarm are purposefully constructed to factor in market volatility for the timeline which is set out by you when setting up a portfolio – something which can be reviewed and amended on your portfolio’s landing page.

They are designed for sustainable growth over the medium to long term, where we can incorporate our views over the long-term prospects of global investments whilst also making tactical tweaks to mitigate against risk factors whilst also leaving the door open for opportunities when they arise. Consequently, proper caution and professional risk management is the best way to ensure success for investors. 

Naturally there may be changes to your situation, for example a change in your circumstances which may mean you will need to use your money sooner than expected, or your perception of risk has changed over time. 

Aside from the plethora of solutions we have available, we also have our team of Investment Consultants who we encourage you to make use of in helping map out your financial goals. They are on hand to discuss ongoing market conditions and how these tie into your planning. You can book an appointment here to talk through your options.