Market Timing and Chasing Returns
Market timing is a strategy wherein an investor buys and/or sells an investment based on predictions about future market events or values.
Trying to time the market by jumping from fund to fund with your retirement account is very risky. Instead, we recommend that retirement investors adopt a long-term investing approach that focuses on steady investing and diversification.
Market timing is just a risky business, especially for amateur investors.
For market timing to pay off, an investor has to be correct two times for each market move. You need to know when the market will go up, and you need to know when it will go down – or vice versa. If you’re wrong about the timing of one of these events, you will likely lose. Even the best day-traders see very mixed results.
A market timing mistake that usually results in investors buying high and selling low – the opposite of good market timing – is chasing returns. People who chase returns move money into investment options that showed the best performance during the previous period.
We’ve all heard the expression hindsight is 20/20; the phrase holds true in many cases, and investing is no exception. Looking back, it might seem obvious that a certain fund or stock or commodity was going to have a stellar quarter – even though you didn’t predict it three months ago. The big mistake lots of investors make, as they look at last quarter’s returns or last year’s returns, is jumping on the bandwagon too late.
The investment you’re considering might continue to do well, but it might not. A recent hot streak does not point to a continuing hot streak. It’s rare for a single asset class to consistently outperform others over multiple periods. In mutual fund investing, it is even rarer that a fund will outperform its peers over multiple periods.
As humans we’re programmed to want to chase returns.
In so many other areas of life, we benefit from choosing a recent winner. Seasoned investors have to fight the urge to chase returns. But every investor is well-served to remember that it’s a strategy that will likely land you a day late and a dollar short – always one step behind.