During long periods when markets remain calm, many retail investors are lulled by the slow and steady upward movement in the value of their portfolios. These are the times when the adage, “time in the market, not market timing, determines performance”, that seems to ring true. However, when volatility rises, often these same investors turn away from “buy-and-hold” and become interested in market timing.
Market timing is simply the strategy of making investing decisions by trying to predict future market price movements. So, for example, in anticipation of a steep market drop, an investor might sell risk assets, such as equities, and raise cash. Attempting to sell assets when prices are high and buy them when prices are low is the basis of market timing.
Unfortunately, most investors discover that market timing is a difficult and unreliable way to build wealth. Even professional investors cannot predict market outcomes consistently. Further, market timers need to be right twice: once when making the decision to sell (and at what price), and again when to buy (and at what price). This increases the probability of errors. Because of this, many investors find it difficult to re-enter the market and deploy their cash and this causes them to miss strong rallies. Paradoxically, investors tend to be more optimistic and likely buy on up days because of FOMO (Fear of Missing Out) and sell on down days due to panic. This is not a recipe for long term financial success.
A better alternative to timing the markets, is taming the markets. A “taming the markets” strategy does not seek to call a market top or bottom, rather it is designed to smooth out periods of extreme market volatility; both excessive losses and gains are tamped. Downward swings can be fast and furious. While the average equity market correction is about 13%, markets have also declined 35% to 55% in recent history, sometimes in a matter of weeks to months. Sitting on the sidelines has also been costly. According to a study by Merrill Edge, a $1,000 in a S&P 500 Index fund from 2009 until 2018 would be worth $3,530; however, missing the 20 best-performing days would reduce the value to $958.
This is why taming the markets is the preferable strategy; it generates gains without the emotional toll that comes with sharp market drops. At ETF Capital Management, when we see the downside risks greater than the upside potential, we tactically shift our portfolios with option strategies to dampen market volatility. Sometimes this means we give up some upside in return for insurance against the downside. But when markets sell off and value develops again, we take off these protective hedges and pivot toward prudent risk. Taming the markets, allows us stay invested over the entire market cycle with our option strategies generating yield along the way.