We shouldn’t time the market, yet we do
In the entry market timing and perspectives on why to avoid it we saw evidence that market timing is a bad idea. Yet many of us still find it difficult to refrain from it. At least implicitly. It almost feels like it’s human nature to try time the market. But why is this the case?
In what follows, I’ll share my personal thoughts on why it’s so difficult not to time the market. These thoughts are structured along the three points:
- We see patterns everywhere
- We are risk averse
- We are not happy being ‘average’
Take them with a grain of salt. These are just my personal theories.
1 . We see patterns everywhere
Humans are extremely good at identifying patterns. We are pattern recognition machines. Medical research supports this [1, 2]. Pattern detection helps us uncover meaningful relationships from the sensory input overflow we receive. It works by making rapid connections between external stimuli and long term memory. And it maximizes chances of survival. Recognizing patterns has certainly worked well for Homo Sapiens over the past 200,000 years.
But the world where we evolved is quite different from the world today. And sometimes we see patterns where there’s nothing. In fact, there’s even a term to describe this: apophenia. Its formal definition is “the tendency to mistakenly perceive connections and meaning between unrelated things […]. Human propensity to seek patterns in random information” [3]. The most typical example is gambling. Roulette gamblers often recognize patterns by looking at the previous n numbers drawn. This is nonsense.
I believe that one of the reasons why it’s so difficult for us not to time the market is, simply, that it’s unnatural to us. Market timing is an excellent opportunity for our brain to put at work its pattern recognition skills. Our inner pattern recognition machine gun fires rounds non-stop. It tells us what will happen next. In which direction markets will move. And it’s difficult to ignore.
2. We are risk averse
We humans don’t like risk. When exposed to uncertainty, we try to lower that uncertainty [4]. Risk aversion makes it difficult for us to take the leap and start investing. What if I invest now and markets crash immediately after? I won’t believe you’ve ever invested any money if this thought has never crossed your mind.
I see a link between risk aversion and market timing. Investing increases uncertainty, and we try to lower uncertainty. So we wait for the right time to invest. For a golden opportunity. We wait for certainty. It won’t come. When everything is going well, stocks will be expensive. When stocks are cheap, there’ll be reasons for you to be even more risk averse. For starters, volatility will be higher. And volatility means uncertainty. The same thing you were trying to minimize in the first place.
In the end, one way or the other, you are left sitting on the side. Waiting for the right moment. Timing the market.
3. We are not happy being ‘average’
This one is more relevant once you’ve overcome your risk aversion and invested some money.
If you invest, you’ll know that it’s difficult to resist the urge to sell when markets crash. Even if you know that, rationally, you should do nothing. Because you know that you can’t time the market. You know that you should just ride out the market bumps. Why is it so difficult to stay the course?
I believe it has do to with the frustration of doing nothing. We’re not used to it. Things happen, and we fix them. The light bulb stops working, we change it. You don’t like your job, you start looking for a new one. The insurance company hikes premiums, we change provider. Our portfolio tanks, we do nothing? Wait. What? Seriously? We’re used to fixing things. We strive to improve our lives on a continuous basis. We fight not to be average. But… you’re saying that now we have to? That this is the best we can do?
You know from this entry that, long term, the answer is yes. But it’s a tough pill to swallow. It’s also difficult for me. But I still try to be an average boy.
You can get better at not timing the market
Do you also find it difficult not to time the market? Don’t despair. Just by acknowledging this limitation you’re already addressing it.
But you can also get better at putting your market timing instincts on a leash. How? This is my personal experience.
We see patterns everywhere: this one is likely the hardest to fight. At least in my experience. Even after years of experience as an investor, your brain will still connect the dots and implicitly predict where markets are heading. You’ll simply learn not to act on these predictions.
We are risk averse: your willingness to take risks will naturally increase over time. We discussed the topic here. In essence, you’ll learn to perceive your wealth as a something fluid. Something that oscillates beyond your control. It’s kind of like when you find out that time is relative [5]. Difficult to accept at first, but assumable at last. Especially if the market value of your investments builds up progressively, which is the case of most. At the beginning, daily variations of CHF ± 100 might cause an emotional response from you. With time, though, you’ll be able to cope with daily changes orders of magnitude bigger. The key is to start early and let your willingness to take risk grow as your wealth does.
We are not happy being average: in my experience, fighting the urge to outperform will also fade over time. At some point, you’ll start to be thankful for the little time commitment your investments require. And you’ll also be amazed by the results. You’ll realize you couldn’t have done better. At least not in a systematic and reproducible way. Not without being dependent on luck. You’ll realize that a buy-and-hold strategy that gives you average returns still sets you apart from the average investor
Last updated on April 23, 2020