Market Timing

Does the timing penalty – the cost of second-guessing the market – make a big difference? You bet it does. The stock market as a whole has delivered an average rate of return of 9.6% over long periods of time.

But that return measures only what a buy-and-hold investor would earn by putting money in at the start of the period and keeping his money invested through thick and thin. The average investor’s actual returns are at least two percentage points lower because the money tends to come in at or near the top and out at or near the bottom.

In addition to the timing penalty, there is also a selection penalty. When money poured into equity mutual funds in late 1999 and early 2000, most of it went to the riskier funds – those invested in high tech and Internet stocks. The staid “value” funds, which held stocks selling at low multiples of earnings and with high dividend yields, experienced large withdrawals. During the bear market that followed, these same value funds held up very well while the “growth” funds suffered large price declines. So the gap between overall market returns and an investor’s actual returns is even larger than those two percentage points.