By Parthajit Kayal and Malvika Saraf
The primary concern one has when investing in the market is about the risk involved in chasing greater returns. Smart investors are well aware that it is impossible to predict a stock’s outcome. Any stock can result in a potential profit or loss, but the hope of “hitting it big” in the markets has led plenty of investors to try and time the market. There is often a debate between time in the market versus timing the market. When attempting to time the market, a stock buyer tries to predict the future market price of a stock. Meanwhile, when one invests to grow wealth in the long term, one buys stocks without trying to guess when the market will behave in a bullish or bearish manner. That brings us to the question, which one should investors be more concerned about?
Why is timing the market difficult?
Timing the market means that a person is trying to predict a stock’s future share price. Although it sounds ideal to “buy low and sell high”, it is often too good to be true. There are always people who just get lucky; someone may have luck with one stock but lose it all on the next trade. There is a high chance of failure with this strategy because the future is uncertain and stock prices change rapidly, implying that it is nearly impossible to accurately and consistently determine when a stock has hit its lowest or highest point. It is financially risky to predict the future, which is why timing the market is not at all recommended. In fact, be wary of any financial advisor who recommends doing so, as it reflects poor judgment and misaligned interests on his part.
Timing the market can have unexpected financial repercussions as well. When working with a broker, frequent trading increases brokerage commission costs. The more stocks bought and sold, the more commission the broker earns. Even worse, the investor has to pay this commission regardless of whether he earns a profit or not.
Market timing easily plays on our emotions in a way that overrides dispassionate and serious investment analysis. If the reasons for one’s belief in a stock change, then it is important that he should be willing to change his investments. However, market timing easily tempts us to jump out too early or stay in too long.
Time in the market
Time in the market, contradictory to timing the market, does not involve short term predictions. Here, the investor will not try to guess whether the market is at its lowest or highest level. He will buy the stock knowing that his timing probably might not be ideal, but that fundamentals matter a great deal more than the timing. If stock is fundamentally strong with higher return-on-capital-employed than the cost-of-capital consistently, short term stock price movements are not that relevant, and therefore, timing does not add any material value.
This strategy proves that time and patience in the market is more rewarding than a mere quick sale. When one holds on to a stock for 10 years, the positive effects of compounding and investment growth reap significant rewards. Patient investors gain a larger profit by allowing their investments to grow over time.
The formula to creating long-term wealth is spending time in the market. By doing so, the investor overcomes the natural market cycles. For some people, it may be hard to invest that much time in the market, but they should remind themselves how it aligns with their financial goals. Maybe they know that they will need the money for retirement or even purchasing a home. By waiting for steady growth over time, smart investors are able to achieve their long-term financial goals.
For anyone weighing the pros and cons of time in the market vs timing the market, it is essential to remember that time in the market offers a better outcome, even if it feels overwhelming amid market volatility and financial uncertainty. By investing in stocks with a long-term strategy, one can balance tolerance for risk with the unique situations of life.
Kayal is assistant professor, Madras School of Economics and Saraf is a recent graduate of Madras School of Economics