What Is Market Timing?

This post has been cited by The Carnival of Financial Planning, edition 95, hosted by Good Financial Cents.

Some say market timing is dangerous to financial health. “Timing the market is a fool’s game,” is how they’d put it. Some investors go so far as to establish investment plans with rules that forbid market timing. By and large, Bogleheads (mostly) frown on market timing. So what is market timing?

Market timing is about how one decides when to make changes in one’s investments. Obviously any change (purchasing new assets, rebalancing, selling, etc.) has to be done at some point in time. The question is: how do you decide what that point in time is? Upon what basis is the timing decision made? Using what information? The answers define market timing.

(Definition) If the basis for the timing of investment changes depends on conditions of the market (e.g. asset prices) then it is market timing. On the other hand, if the timing is due to indicators that are not functions of market conditions (like your age) then it is not market timing.

Let’s consider some examples.

(Example 1) The market crashed. Stocks are half the price they were six months ago. You sense they are “cheap,” that they can only go up. (Sound familiar?) You decide to pour your savings into stocks. Ruling: market timing.

(Example 2) You have an investment plan that says that you will shift from an 80/20 equity/bond mix to a 70/30 one when you reach age 30. So on your 30th birthday, that’s what you do. Ruling: not market timing.

(Example 3) You have an investment plan that says you will rebalance on January 1 each year to maintain your planned asset allocation. Hangover or not, you do so faithfully each year. Ruling: not market timing.

(Example 4) Your parents just gave you a five figure gift. You put it in your money market while you think about what to do. You notice emerging markets have done very well lately. You imagine that they’ll continue to do well. While you previously had no intention of tilting your portfolio toward emerging markets you dump the money into an emerging markets index. Ruling: market timing.

This last example, and to some extent the prior one, is tricky. One is always free to adjust one’s plan. Maybe you convince yourself that you really should tilt toward emerging markets. If that is really your new plan and you put it in writing and swear up and down you’ll stick with it then you might convince me that Example 4 is not market timing. But then you cannot justify the timing of the move based on asset prices. You have to justify it on the soundness of your plan. You should be indifferent as to the specific purchase date. There’s room for psychological gamesmanship here. One has to be brutally honest with oneself if one wishes to avoid market timing.

As for Example 3, isn’t rebalancing in some sense a function of the market? If, for example, stocks did poorly relative to bonds then one would need to shift assets from bonds to stocks. That is a move based on market performance, isn’t it? Yes, it is. Still, it is not market timing because the timing of the adjustment is not based on the market. It is based on the calendar. Planned, periodic rebalancing is not market timing.

Notice nowhere have I said that market timing is always definitively bad. Many may believe that, but I’m not going to take a stand here. My objective is just to define the term. Now that we’ve done so, each of us is free to decide how we feel about market timing and whether it is ever justified.

Now some bonus questions: (1) How did you decide your stock/bond mix? (2) Wasn’t it based on future expected average returns? (3) If so, is that market timing? (4) If not, upon what was your asset allocation based? My answers are: (1) careful investment planning (about which I will blog soon), (2) yes, (3) no, (4) N/A. Extra credit question: If my answer to (2) “yes” how can my answer to (3) be “no”?

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