Investing in the stock market, which is as much about art as it is science, often centers around the strategy of market timing.

Buying low and selling high makes intuitive sense, but implementing it successfully over the long term is challenging. As you navigate these turbulent financial waters, remember you’re not alone.

Market Timing Misconceptions: What Truly Drives Success

One of the greatest critics of market timing was Peter Lynch, who headed the Magellan Fund to excellent returns between 1977 and 1990. The legendary Investor strongly criticized market timing. He argued that market timing distracted any investor from the more reliable investment strategies.

His view can be a guiding light for us in our investment approach.

One of his quotes best represents his thinking and can be illustrated best by his example given to Worth Magazine in 1997. He described three investors, each of whom invested $1,000 per annum from 1965 to 1995 under different timing conditions:

• Investor 1 (Unlucky): Buys at the yearly high.
• Investor 2 (Lucky): Buys at the yearly low.
• Investor 3 (Start-of-Year (SOY)): Buys yearly, on the 1st of January each year.

Who comes out on top? Surprisingly, it’s not the master of market timing, Investor 2.

You’d expect Investor 2 to easily beat the unlucky Investor 1 and surpass the steady Investor 3, but the results are closer than you’d think.

Yet, surprisingly, over three decades, their returns are remarkably close.

Annual Returns Are Surprisingly Similar

• Investor 1 (Unlucky) earned 10.6%,
• Investor 2 (Lucky) earned 11.7%,
• Investor 3 (SOY Investor) earned 11%.

This demonstrates that an intense focus on perfect market timing offers only minor advantages over a steady, consistent investment strategy.

A recent study replicated Lynch’s analysis using current data to evaluate his thesis against today’s market conditions. It assessed the performance of three major US equity ETFs from 1994 to 2020, providing a fresh perspective on the effectiveness of Lynch’s insights over this period.

• SPDR S&P 500 ETF (SPY): Tracks large-cap U.S. stocks.
• iShares Russell 3000 ETF (IWV): Covers a broad range of U.S. stocks across all capitalizations.
• Invesco QQQ Trust Series 1 (QQQ): Focuses on major NASDAQ non-financial enterprises.

The study modeled three types of investors:

• Unlucky Investor: Consistently bought at the annual high.
• Lucky Investor: Consistently bought at the annual low.
• Start-of-Year (SOY) Investor: Bought at the start of each year.

Key Findings:

Old Study (Peter Lynch) – 1.1% Annualized Difference Between Lucky and Unlucky Investor

If you have $10,000 and invest it with perfect market timing, you would make an additional 1.1% per year compared to investing at the worst times.

• Unlucky Investor: Suppose the Unlucky Investor makes 10% annually. After one year, the investment grows to $11,000 ($10,000 + 10% of $10,000).

• Lucky Investor: The Lucky Investor makes 11.1% annually. After one year, the investment grows to $11,110 ($10,000 + 11.1% of $10,000).

New Study – 1.5% Annualized Difference Between Lucky and Unlucky Investor

If you have $10,000 and invest it with perfect market timing, you would make an additional 1.5% per year compared to investing at the worst times.

• Unlucky Investor: Suppose the Unlucky Investor makes 8.71% annually. After one year, the investment grows to $10,871 ($10,000 + 8.71% of $10,000).

• Lucky Investor: The Lucky Investor makes 10.21% annually. After one year, the investment grows to $11,021 ($10,000 + 10.21% of $10,000).

Over 10 Years

To see the power of compounding, let’s look at these differences over 10 years:

• 1.1% Difference Over 10 Years:
  • Unlucky Investor: $10,000 invested at 10% annually grows to approximately $25,937.
  • Lucky Investor: $10,000 invested at 11.1% per year grows to approximately $28,685.
• 1.5% Difference Over 10 Years:
  • Unlucky Investor: $10,000 invested at 8.71% per year grows to approximately $22,982.
  • Lucky Investor: $10,000 invested at 10.21% per year grows to approximately $26,502.

Here’s how each investor would have performed in the S&P 500 between 1994-2020 with a $10,000 investment per year over 27 years and an annual return of 10.21%, illustrating the power of staying invested regardless of market fluctuations.

The Real Truths About Market Timing:

1. Market Timing is Less Important Than Staying Invested: The study supports Peter Lynch’s conclusion that the difference in annualized returns between perfect and worst market timing is relatively tiny.
2. Small Performance Differences: The minor differences in performance between the three types of investors are insignificant: even the Unlucky Investor, who buys at the highest price each year, still achieves a respectable return.
3. Consistency Matters: The SOY investor who invests at the beginning of each year receives returns nearly as good as the lucky Investor who buys in at the low each year.
4. Importance of Market Exposure: Research shows that what you invest in, like a specific ETF or index, matters more than when you invest. Over the same period, the Unlucky Investor in the QQQ ETF earned more than the Lucky Investor in SPY or IWV.
5. Compounding Returns: This, over time, tends to mitigate the effects of bad marketing timing. In a long-term investment, being in the market will return in a likable way, which is not the case with short-term market volatility.
6. Volatility and Long-Term Gains: The study acknowledged that market declines and corrections are inevitable, but staying invested allows portfolios to benefit from market recoveries.