Market timing is one of the most complex and confusing topics in investing.
There is plenty of research out there which shows that trying to time the market is a waste of effort and investors who do so usually end up missing significant moves, which costs them valuable percentage points in performance.
The better strategy, research argues, is to buy stocks and hold them for the long term. Like all investment strategies, this approach may have a place in some investors' portfolios, but it cannot be ignored. Some of the greatest investors of all time have made the majority of their money by timing the market successfully -- or so it seems at first glance.
What is market timing?
Warren Buffett (Trades, Portfolio) and Charlie Munger (Trades, Portfolio), for example, are willing to wait years for the perfect opportunity to arrive before they deploy cash. In the run-up to the financial crisis, Munger sat on his hands for years at the Daily Journal (DJCO, Financial), where he acts as chairman, before making a move, spending millions of dollars to acquire shares of companies like Wells Fargo (WFC, Financial) at deeply discounted prices.
Buffett did the same, sitting on his hands in the years before the crisis before moving quickly to deploy tens of billions of dollars in Berkshire Hathaway's (BRK.A, Financial)(BRK.B, Financial) capital as the crisis unfolded, becoming a lender of last resort to companies such as Goldman Sachs (GS, Financial) and Mars.
At first glance, these actions look like market timing, but are they really? There are many other examples of investors waiting for decades to buy stocks before acting at the opportune moment, usually when the market crashed. But is this market timing, or is it just waiting for the perfect opportunity?
In my opinion, it is the latter. The investors I am primarily talking about here, Buffett and Munger, are not trying to time the market. Instead, they take advantage of opportunities when they present themselves. These are two different things. The gurus are well aware that if they buy stocks, they may suffer a period of underperformance in the months and possibly years immediately following.
At the same time, when they buy stocks, they either buy because there is a catalyst on the horizon or they plan to hold them forever. That's clearly not market timing. To the untrained eye, it might seem as if these investors are trying to time the market, but setting strict investment criteria and waiting until these guidelines are met before acting is not market timing.
To use Benjamin Graham's Mr. Market analogy: If Mr. Market offers you the opportunity to buy assets at a deeply discounted price, that's not market timing because you're not trying to outsmart him.
Not possible
To make it clear, I do not think it is possible to time the market. Based on my research and understanding of well-known investors' strategies, the best way to invest is to set strict rules for finding value and then adhere to them -- no matter what the market is doing.
Trying to second-guess if the market is going to rebound from a low or fall from a high is a waste of time and effort. The best strategy is to set a price target to buy and a price target to sell based on your own proprietary research. These targets will only change if the situation changes. And if the price target is not reached? Then the opportunity is probably not worth chasing.
These are just some thoughts on what I believe to be one of the most misunderstood topics in investing. It is best to ignore the noise and set your own price targets, just as the father of value investing, Benjamin Graham, initially advised.
Disclosure: The author owns shares of Berkshire Hathaway.
Read more here:
- Buffett Could Make 50% a Year, but Maybe Not With Deep Value
- The Sequoia Fund's Strategy for Outperformance
- Does Warren Buffett's Long-Term Investment Focus Hold Him Back?
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