However, many investors do try to beat the markets using a strategy called market timing. This strategy involves holding an asset while waiting for a market correction or selling stocks high in the hopes of buying them up again at a low. Some well-known and popular financial gurus are particularly outspoken about their ability to predict market trends. But can they be trusted?
Nobel Laureate William Sharpe examined market timing in his study Likely Gains from Market Timing. He concluded that a market timer must be accurate 74% of the time in order to consistently outperform the market at a comparable level of risk.
This threshold is nearly impossible to attain. The website Index Fund Advisors tracked over 3,500 forecasts issued by financial gurus between 2000 to 2012 to determine their accuracy. Ken Fisher scored the highest, with 66% accuracy. So in reality, not one of the gurus was able to reach the 74% threshold. A simple passive index portfolio would have performed better.
Stock markets can be volatile, and are unpredictable over the short or medium term. They can turn on a dime, much to the dismay of investors who attempt to capitalize on short-term fluctuations. If even the experts have shown themselves to be unable to time the market with enough accuracy to beat the index, why do so many investors fall for this strategy?
An indicator of poor diversification
We believe that thousands of investors favour market timing because their portfolios are poorly diversified. When a portfolio is well diversified, bonds serve to cushion it against market downturns. Stable bond returns can partially compensate for negative returns on shares. When the portfolio is rebalanced, investors can take the opportunity to snap up shares at a lower price by leveraging their bonds, which maintain steady prices during a bear market. Over the long term, diversifying your investments will ensure steadier high returns.
To learn how, seek out the expertise of an investment advisor.
Jean-Philippe Bernard is an advisor for National Bank Financial. National Bank Financial is an indirect wholly owned subsidiary of National Bank of Canada. National Bank of Canada is a public company listed on the Toronto Stock Exchange (NA: TSX). The opinions expressed herein do not necessarily reflect those of National Bank Financial. The particulars contained herein were obtained from sources we believe to be reliable, but are not guaranteed by us and may be incomplete. The securities and sectors mentioned in this document are not suitable for all types of investors and should not be considered as recommendations. Please contact your Investment Advisor to find out if a security or sector is suitable for you and to obtain more information, including the main risk factors.