by Harry Sit on September 13, 2011 2 Comments

In the previous post Market Timing vs Conservative Portfolio I explored a possible valid reason for market timing.

Proponents say that market timing isnt so much for enhancing returns but for reducing risks. Although market timing underperforms the market, an investor with low risk tolerance would invest in a conservative portfolio anyway, which also underperforms the market. Its not clear whether a portfolio that invests 50% in stocks all the time beats a portfolio that invests 70% in stocks at some times and 30% at some other times.

I continue to play devil’s advocate for market timing and see if it can be one of many roads to Dublin. Vanguard founder John Bogle strongly advocates indexing and buy-and-hold. He wrote about the perils of market timing in his book Enough. How do proponents of market timing answer the criticisms from Mr. Bogle?

Not Everyone Can Time the Market

Mr. Bogle wrote:

[T]he inescapable fact is that, for investors as a group, there is no market timing. For better or worse, all of us investors together own the total market portfolio.

This is absolutely true. However, its not much of a concern for any individual investor. Some academics and investment advisors say one should put more money in value or small cap stocks. Not everyone can do that either. For the amount an individual investor wants to buy or sell, the market is more than liquid enough.

No Rationale for Decision Making

But on what rationale will we base our market timing? On our conviction about the prospective equity premium? Concern about the known risks that are already presumably reflected in the market prices? Concern about the unknown risks?

Some forms of market timing require assessing valuations, interest rates, and other macroeconomic factors. Some other forms are purely mechanical, driven by the price movements. The mechanical systems dont care about equity premium or which risks are known or unknown. The buy and sell rules are defined ahead of time. No subjective hand-wringing, crystal ball gazing, or waiting for a gurus alert.

No Consistency

Mr. Bogle also wrote:

Dont forget that your incredible success in consistently making each move at the right time in the market is but my pathetic failure in making each move at the wrong time. I dont know anyone who can do it successfully, nor anyone who has done so in the past. Heck, I dont even know anyone who knows anyone who has timed the market with consistent, successful, replicable results.

Not every move has to be right. Requiring consistency sets the bar too high. Market timing can be successful as long as the good moves balance out the bad moves over time. As Michael Kitces wrote in If Clients Are Naturally Loss Averse, Why Dont We Invest For Them That Way? even if there is no financial benefit, the psychological benefit from not having to go through a V can be a good enough reason.

Must Be Right Twice

Mr. Bogle continued with:

It is difficult enough to make even one timing decision correctly. But you have to be right twice. For the act of, say, getting out of the market implies the act of getting in later, and at a more favorable level. But when, pray?

If being right means that the market drops after you sell or the market rises after you buy, you dont have to be right twice. Being right once is good enough. If the market drops after you sell, you can buy back at a lower price  at any point. It doesnt matter if the market continues to drop after you buy. Actually you dont even have to right once all the time. As long as the gains when you are right exceed the losses when you are wrong, market timing can still be worthwhile. Not saying this will be easily achievable, but you really dont have to be right twice all the time.