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Chapter 7. Timing the Market > Market Timing and Risk

Market Timing and Risk

One last misconception about market timing warrants discussion. It is common for market timers to claim that a portfolio that is invested in stocks part of the time, and in cash the other time, is less risky than a portfolio that is always invested in stocks. Although this might be true, the risk in a market-timing portfolio is higher than proponents typically admit. For example, consider the timing portfolio that is completely invested in the stock market 50% of the time and in cash the other half of the time. Is there the same risk as always allocating 50% of your assets to stocks and 50% to cash? The answer is no. The following example demonstrates the principle.[17]

Consider the market timer who is correct in forecasting the stock market exactly 50% of the time. That is, this ability neither helps the portfolio's return nor hurts the return in the long run. This stock market will earn either a 100% return or –50% each year with the same likelihood over the four-year period. Cash will earn a 0% return. Compare the outcome with the investor who allocates 50% to stocks and 50% to cash and a buy-and-hold investor.


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