Market timing ignores some basic facts

Watch financial TV and you’ll see various gurus engaging in market timing, predicting when the market will surge or crash and advising others to buy or sell “now.” Unfortunately, they’re often wrong. No one can consistently and accurately know what the market will do in the short term. In the long term, though, the trend is clear: The market rises.

Market timing was studied by University of Michigan finance professor H. Nejat Seyhun for Towneley Capital Management. He noted that an investment held in the stock market from 1963 through 1993 (7,802 business days) would have yielded a solid average annual return of 11.83 percent. But get this: He found that if you were out of the market (i.e. not invested in it) for the 10 days when the market rose the most, your average annual return would be only 10.17 percent. If you sat out the 90 best days, you’d be down to a mere 3.28 percent.

Much of the market’s gains can occur on just a few days. So anyone who tries to time the market risks missing out on substantial profits. Some will argue that by being out of the market on the worst days, you’ll improve your returns — but no one can correctly predict when those worst days will occur, either.

You may be a market timer without even realizing it. For example, you may mean to hold onto a solid investment for the long run, but after a relatively short period of lackluster performance, you lose faith and sell, moving into another short-term holding. To combat this tendency, take the time to learn more about how you’re investing and have more confidence in your plan.

Over the long run, it’s usually more hazardous to your wealth to be out of the stock market than to be in it. By hanging on, you’ll be in the market on days when it counts, able to ride out occasional downturns. A great strategy is to regularly invest in the market, whether it’s up or down, perhaps through an index fund. Learn more at http://moneycentral.msn.com/content/P18323. sp and www.indexfunds.com.

Ask the Fool

Q: I’m a teenager. Where should I invest my money? — F.R., Mobile, Ala.

A: College money shouldn’t be in stocks, as the market could drop in the short term. Long-term investments can patiently ride out downturns, so consider keeping money you won’t need for five or 10 years in stocks. Short-term investors should stick to safer plays, like money market funds or CDs.

My dumbest investment

In 1991, I inherited $10,000. I wanted to put it in a safe investment to go to my children. A “broker/friend” convinced me to invest it in a life insurance policy because of its tax benefits. Well, the insurance company has withdrawn sums every year from my policy to cover “premiums.” In 1996, my death benefit was $44,167. Today it’s just $35,336. Cash value: $9,180. — Evelyn Luddke, Tulsa, Okla.

The Fool Responds: Ouch. You might consider taking the cash value and moving the money into an investment more likely to grow than shrink.