Market Timing

Commentary from John Montgomery of Bridgeway Capital Management

Don’t do it. In fact, if you have long-term faith in the U.S. economy, you may even do well buying high rather than low, as long as you hold on long enough.

A large percentage of investors tend to buy after a significant runup and sell during down periods. This is a formula for horrible investment results. There have been two studies by financial magazines and at least one academic study documenting this phenomenon. Morningstar recently published the following data:

Fund A average annual return 17.5%

Fund B average annual return 19.5%

Which fund would you own? The sad truth is that more investors made money with Fund A than Fund B.

Fund A typical investor’s actual return 19.2%

Fund B typical investor’s actual return 16.8%

The returns of Fund B were more erratic, and people bought after a period of good performance, and sold in a downturn. This is not an isolated phenomenon. Wilshire Associates' Stephen Nesbitt studied the gap between portfolio returns and shareholder returns from January 1984 through August 1994 and found that investors’ returns were 1.1% less than the average 11.0% return of their funds. Morningstar’s conclusion: "Invest in a fund you can stick with." As applied to Bridgeway, this probably means that you should only invest in our higher octane funds (Micro-Cap Limited (closed), Ultra-Small Company Tax Advantage, and Aggressive Investor 1) if you can stomach the short-term volatility. (See the prospectus for more details.)

If you cannot stomach the higher short-term volatility of stocks, you will probably end up with subpar returns. If you want to try to "steel" yourself for the next downturn, expect it and ignore it, you might try reading the October 2001 paper, "Surviving a Bear Market and Crisis Events," from which this material on market timing was taken.