Why Market Timing is Especially Bad for Retirees
Buy low and sell high is a proven strategy that can make you millions. You have probably thought about a trade or two, even if you haven't made any moves lately. Who wouldn't want to boost their returns just by shifting their money around a little bit? It's tempting. Although I advocate buying and holding index funds, I have to tell myself constantly that market timing is a bad idea just to keep myself from giving it a go. Here's why market timing using your retirement savings is risky.
One wrong move can derail your retirement plans. Market timing is an attempt to outsmart the market, but the market is extremely efficient. While many people can make extremely astute trades in one or two market cycles, it's doubtful that anyone can time the market consistently through decades. Market valuations tend to turn very quickly. If your investments are in cash when the tide turns just once, you could be looking at permanently missing out on the market gain.
The tax cost of market timing is huge. You will need to pay capital gains taxes on your investment gains when you go in and out of the market. You typically need to hold on to an investment for at least a year to qualify for the typically lower long-term capital gains tax rate. Shorter term capital gains are taxed at regular income tax rates. To profitably time the market, you have to reap enough of a reward to make up for the tax consequences. Therefore, you not only have to be right about the direction of the market when you sell, but you also have to capture a big enough investment gain to make up for the extra tax costs. Even if you are successful at timing the market, you will be selling chunks of investments, causing many of your gains to be taxed at a high rate.
You may not want this part-time job. Market timing takes time. While executing the trades obviously doesn't take that long, accruing the knowledge to know when to sell and buy involves hours of reading. And if you don't know anything about what you are selling and buying, you're gambling, not picking investments based on skill. You spent many years working so that you could afford to retire. Do you really want to trade one job for another?
Deviating from the market can be nerve wracking. I was once a day trader. In fact, I was pretty successful at it. But I still recommend index funds now. Why? Because watching all my investments like a hawk and trading in and out of equities is nerve wracking. I was impatient and moody when I was day trading. You will be nervous about your moves when you are out of the markets and the market is up that day. You may not want this stress when you are trying to enjoy a comfortable retirement.
You may not be able to keep trading as you age. We all age and our brain slows down. You may be able to successfully pick stocks now, but you probably can't keep up the performance forever. You can certainly stop trading before that day comes, but only if you can somehow recognize the relentless but slow decline in cognitive ability. To be a successful market timer, not only does your timing with investments need to be impeccable, but you must also time your exit from this strategy with precision. You don't want to erase years of investment gains because you didn't know when it was time to stop.
Your retirement is on the line. Do you feel lucky?
David Ning is the founder of MoneyNing.com.
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