Mark T. Hebner

 

So I have some good news and some bad news about investing. The good news is the appetite for indexing and index funds is growing. The bad news is investors cannot completely cut the cord on their prediction addiction. As a result, market timing with ETFs has become enormously popular. Unfortunately, their performance has not justified their popularity.

ETFs are portfolios of stocks, bonds and in some cases other investments that get traded on a stock exchange a lot like a regular stock does. And these ETFs are almost all index funds. That doesn’t sound so bad, right? Well, on the surface it’s not, but the snakes are now coming out of the grass in huge numbers, corrupting a sound investment strategy. Hundreds of high-fee advisors and newsletter/subscription services have cropped up to “assist” investors with timing ETFs. One of these services even promises to use the “FibTimer trading strategies.” How ironic is that? 

The list of problems that occur with timing ETFs is a long one, but here are a few:

One problem is it follows the belief that somehow the ETF is priced wrong. This of course is a problem that plagues all kinds of stock picking and market timing “strategies.” All the current news and the probability of future news are built into the ETF’s price already.

Another huge problem with the trading of ETFs is investors aren’t exposing their assets to a consistent risk exposure over time if they are pulling their assets in and out of the market. Just how reckless is this behavior? The Dalbar Investor Behavior Studies have been tracking these practices for a long time. Not so surprisingly, they found the investor was only getting about 25% of the fund’s potential return over these periods because of their stubbornness on trading in and out of these funds.

Why do investors fall prey to these charlatans who tell them they can predict the market? The main reason is no one wants to settle for “average.” But average returns are really the superior returns. If investors had bought and held a globally diversified Index Portfolio for the last 20 years, they would have an average annualized return of 9.55% per year, and they would have had about as much risk as the S&P 500 Index which delivered 8.06% over the last 20 years. Buy and hold works best, but you must not forget the hold.

The landmark and definitive study of market timers was conducted by John Graham at the University of Utah and Campbell Harvey at Duke University. The professors painstakingly tracked and analyzed over 15,000 predictions by 237 market timing investment newsletters from June, 1980 through December, 1992. By the end of the 12.5 year period, 94.5% of the newsletters had gone out of business, with an average length of operations of about four years! William Bernstein once said, "There are two kinds of investors, be they large or small: those who don't know where the market is headed, and those who don't know that they don't know. Then again, there is a third type of investor - the investment professional, who indeed knows that he or she doesn't know, but whose livelihood depends upon appearing to know."

I challenge market timers to show me monthly statements from an actively managed portfolio carrying the same risk metrics that beat this buy and hold approach over the last 10 years. Go ahead, dig into the data. Timing is a bad idea, even if you do it with ETFs.

As Charlie Ellis said, “Market timing is a wicked idea—don’t try it ever.”