Can going in and out of the market give you better returns?
Ric Edelman is a co-founder of Edelman Financial Engines. The following is taken from his weekly radio call-in show.
Question: What’s your take on managing one’s 401(k), IRA or taxable account using stock charts — i.e., buying/selling ETFs or stocks based on trends, momentum of stocks, etc.? Perhaps one would not make as much money because of not being fully invested all the time in the market, but wouldn’t this method also keep you from losing large amounts in short periods, especially in bear markets? In other words, I am talking about technical analysis. If I have the time, wouldn’t this be a viable alternative to having a firm such as yours manage my portfolio?
Ric: No, it isn’t a viable alternative. If it were, everyone would be doing it and getting rich. Market timing doesn’t work, and charting/technical analysis, which is a form of market timing, doesn’t work either. You won’t be able to find anyone who consistently and over long periods beats the market that way. I know of no chartist who correctly called the 2008 credit crisis, for example.
The reason it doesn’t work: No system is capable of telling you when to get out and when to get back in. You have to be right every single time, because one incorrect call wipes out every previous correct call.
I’ve never seen any system that has been right most of the time, and even if one existed it wouldn’t matter — because the few times it erred would destroy the value of all the other times that it was right.
Here’s an example: A couple of years ago, a guy bragged to me that he correctly predicted the 2008 credit crisis, and he sold in 2007 when the Dow Jones Industrial Average was still near its high (at the time, around 11,000). I asked him when he got back in, and he said he never did.
So, he made one right call (got out at the high) but then made one wrong call (never bought back in). The result was that he was far worse off than if he had made no call at all: Staying in would have taken him down to a 6,700 on the Dow, but then he would have ridden it right back up again to today’s level of 27,000 — about twice as high as when he made his right call. So being right only once was very costly to him.
Avoid such folly and ignore the slick salespeople who are trying to convince you to engage in it.