For the market timer we assume that they remain invested in shares at all times but will switch to cash when shares under perform. When the return for shares for the most recent 12 months falls below the return for cash, the market timer will switch from shares to cash. Conversely, when the 12 month return of cash falls below that of shares, the market timer will switch back to shares. We assume that most market timers have a longer term view than that of a market trader and will therefore hold any position for a minimum of three months and will implement each decision after three months of confirming data.

The market timer was able to enhance their return above Cash and yet reduce their volatility below that of a purely Shares only holder. The volatility of their return, as measured by the Annualised Standard Deviation, was 15% lower than that of an all Share exposure (14.98 versus 17.59).

The Strategic approach paid off handsomely. The risk adjusted return benefit of 1.43% per annum would have resulted in the Strategic Investor’s portfolio being 43% higher than the Market Timer’s portfolio over the 28 year period - without taking any additional risk. This was a period that included its fair share of market volatility including the 1987 crash and the tech bubble deflation.

And this result is understated. We have not included the performance drag of the costs associated with implementing the market timing decisions (transaction costs and capital gains tax).

Summary

The desire to market time is inherent in all humans – we love to stamp our mark on things; we are inherently over confident and we all possess an inbuilt ‘prediction addiction’. In most situations in life when things aren’t’ going as we want or expect them, a little added effort and activity is the solution. However, in the game of investing, more activity is not necessarily the answer. Good investors recognise their natural human instinct to react to market volatility and work hard on overcoming their ‘need’ to react. They are disciplined with their actions and patient with respect to results. Over the long term, the odds are in their favour.

[1] Transactions costs and capital gains tax

[2] Cash is represented by the UBS Warburg 90 day Bank Bill Index & Australian Shares is represented by S&P/ASX 300 Accumulation Index.

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