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Chapter 14. In the Long Term … Myths abo... > Theoretical Roots: Market Timing

Theoretical Roots: Market Timing

Hindsight is the most powerful weapon in the arsenal of those selling market timing. Consider, they say, how much money you could have made if you had bought into the NASDAQ in 1992 and got out at the end of 1999. The essence of market timing is that it lets you capture upside risk and avoid downside risk. This section looks at two widely made claims about timing equity markets.

Market Timing Trumps Stock Selection

In a 1986 article, a group of researchers[1] raised the shackles of many an active portfolio manager by estimating that as much as 93.6% of the variation in quarterly performance at professionally managed portfolios could be explained by asset allocation, that is, the mix of stocks, bonds and cash at these portfolios.[2] A different study in 1992 examined the effect on annual returns of an investor being able to stay out of the market during bad months.[3] It concluded that an investor who would have missed the 50 weakest months of the market between 1946 and 1991 would have seen his or her annual returns almost double, from 11.2% to 19%. In an assessment of the relative importance of asset allocation and security selection of 94 balanced mutual funds and 58 pension funds, all of which had to make both asset allocation and security selection decisions, about 40% of the differences in returns across funds could be explained by asset allocation decisions and 60% by security selection.[4] When it comes to the level of returns, almost all the returns can be explained by the asset allocation decision. Collectively, these studies suggest that the asset allocation decision has important consequences for your returns, and its importance increases with your time horizon.


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