• 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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    • I have a different view about example 1 as market timing. Say you start with 50/50 split in cash and stock. Market nose dive and you end up with a 67/33 split. So you are just rebalancing by buying some stock with your cash to restore the 50/50 split. Of course there maybe some timing element involved in choose which date to rebalance v.s. a strict schedule. But as long as it loosely follow some annual or semi-annual schedule I would just consider it as rebalancing.

    • @Wai Yip Tung – As I wrote, market timing is about timing. So, if your rebalance date is independent of market conditions I would not call it market timing. If you rebalance on a date so as to try to take advantage of the market then it is market timing.

    • If you are not saying whether it is always definitely bad, what does it matter whether one move is or isn’t market timing? How do you decide whether to take a particular action or not? If a move is market timing but it’s good, then do it. If a move isn’t market timing but it’s bad, then don’t do it.

    • @TFB – I agree that it is not useful to know what market timing is if you don’t have any reason to apply the concept. I don’t want to argue with someone who thinks market timing makes sense in some circumstance or another. I believe my true feelings about market timing are clear in the post even though I claim that I’m not taking a stand. If anyone would like me to be more explicit then here it is: I’ve never met a market timing argument I agree with. But I’m not going to debate it. That’s all I’ll say.

    • I know this post is old, but here is my take on another example:

      You have a WRITTEN plan in place that you follow faithfully, and in that plan you declare that your ideal mix is 80/20. You don’t rebalance on a fixed schedule (like every month, quarter, year, 5 years): but the rule for rebalancing is that you rebalance only when you exceed 85/15 or 75/25. You might rebalance next week, or you might not rebalance for years — you don’t predict when you rebalance, you are just defining the criteria for when the rebalance happens.

      In the yearly automatic rebalancing: you are defining WHEN to rebalance, but the AMOUNT of money movement is unknown.

      In my example: the AMOUNT of money movement is defined, but the WHEN part is unknown.

      Is my example market timing? Why or why not?