Course 106: Methods for Investing in Mutual Funds
Waiting, or Market-Timing
In this course
1 Introduction
2 Waiting, or Market-Timing
3 Investing All At Once, or Lump-Sum Investing
4 Why Dollar-Cost Average?
5 Decision Time

Let's start with the first route, holding off on an investment until you sense the time is right. That can mean when the fund's performance falls, when it rises, or when the moon is full on an odd-numbered day of the week in a month beginning with J. Such a strategy is often called market-timing.

As you can probably sense, we're not keen on market-timing. Evidence suggests that it just doesn't work. Predicting the future has never been easy—just ask anyone who has had his or her fortune told. Further, studies from Morningstar have shown that investors' timing often leaves something to be desired—they buy in when a fund is ready to cool off and sell when its performance is ready to pick up. And even if you make the "right" market call, the mutual fund world usually doesn't reward you in a dramatic enough way to make the risk worth it.

Chalk it up to the cruelty of mathematics, as illustrated in an experiment conducted by Morningstar. We went back 20 years and assumed that in each quarter, an investor chose to own all stocks (represented by the S&P 500) or all cash (in our experiment, Treasury bills). A market-timer who picked the better performer half the time still ended up way behind the market after two decades. We found that not until the timer's hit rate reached 65% did he beat the S&P 500. In other words, the market-timer had to be right two out of three times to justify the effort.

This is largely because over time, the stock market has notched higher gains than holding cash. Botching a market-timing decision usually means sacrificing good performance. Worse still, missing a period of strong returns means giving up the chance to make even more on those gains, thanks to the effects of compounding. (That is, each year you earn returns on the returns you earned in prior years, as well as on your initial investment.)

Next: Investing All At Once, or Lump-Sum Investing >>


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