A friend, David Leo, sent me his newsletter recently that contained an eye-popping statement:
“Although the stock market had a return on investment of 9,399.31% or 11.72% per year between 1982 and 2022, 10 of those 41 years saw negative growth.”
This statement grabbed me on two levels. First, during a period that included six bear markets, including the tech bubble and the Great Recession, the market produced outstanding returns.
If I’d been smart enough to invest $10,000 in the early years of my career and resilient enough to weather the ups and downs, I would have been sitting on $939,931 at the end of last year.
That is an incredibly good result. If I’d had a good financial advisor who encouraged me to keep investing on a regular basis over those years, I’d be rolling in clover.
But that outcome would have come at a cost. Six bear markets and a down year 25% of the time is a pretty bumpy road. Terrifying, if you’re not prepared for it.
There’s got to be a better way, right? Who wouldn’t dream of a smoother path?
Certainly, you can dial down the volatility of a portfolio by adding assets like bonds that will reduce the pounding (most of the time), but then you give up some of the upside.
Can’t you just step aside and avoid the downdrafts, while keeping those great returns? No pain, all gain. A dream come true.
It’s Not That Easy
Adeptly bobbing and weaving through the ever-changing financial markets sounds like a great way to protect clients during turbulent markets. But it’s the dream that never comes true.
The problem isn’t that market timing never works. The problem is that it works just enough to give you hope, but not enough to improve performance over the long term.
The research seems quite clear on that point.
A 2016 paper by Wim Antoons, “Market Timing—Opportunities and Risks,” surveys some of this research and offers additional evidence against the efficacy of market timing.
Antoons reviews research done by the CXO Advisory Group, which collected timing predictions made by 68 different market timing gurus between 1999 and 2012. The data showed that 42 of the 68 gurus (61.8%) were accurate less than 50% of the time.
Antoons studied the CXO data for the period 2005 through 2012—a total of 6,582 forecasts—and found that “after transaction costs, no single market timer was able to make money.”
These results led him to conclude: “There are two kinds of investors: those who don’t know where the market is going and those who don’t know what they don’t know.”
Morningstar, too, has done a number of studies in recent years documenting the success or lack thereof of tactical asset allocators, who attempt to time the markets to smooth out the bumps.
In a 2021 article “Tactical Asset Allocation: Don’t Try This at Home,” Morningstar found that tactical allocation funds significantly lagged funds that didn’t vary their allocations (“strategically allocated funds”) over the 3, 5, 10, 15, and 20-year periods studied.
Amy Arnott, the article’s author, concluded, “The failure of tactical asset allocation funds suggests investors should not only stay away from funds that follow tactical strategies, but they should also avoid making short-term shifts between asset classes in their own portfolios.”
In a 2022 article, “Have Tactical Asset Allocation Funds Earned Their Keep?,” Morningstar’s John Rekenthaler compared the performance of tactical allocation funds to various types of more strategically allocated funds. Once again, the tactical funds fell short on their promise.
Over the decade 2012 through 2021 the tactical funds underperformed the most comparable strategically allocated funds by 3% annually. His conclusion about the tactical funds: “Regrettably, they fumbled the ball. I see no reason to invest in such funds.”
In 2023 Morningstar published an article, “They Came. They Saw. They Incinerated Half Their Funds’ Potential Returns.” This study reviewed the performance of tactical allocation funds over the decade ending April 30, 2023.
What the article’s author, Jeffrey Ptak, discovered was not a pretty picture. The 34 funds that comprised the tactical allocation universe returned a mere 2.3% annually—roughly one-third of the return of a simple 60/40 portfolio. More than half the tactical funds died along the way.
Then Ptak studied the performance gap between the tactical funds’ actual performance and what their performance would have been if their managers had simply done nothing over the 10-year study period. The do-nothing strategy generated a 4.6% annualized return—twice the return actually generated by those funds.
A 2022 study by Vanguard, “Tactical Versus Strategic Asset Allocation,” reached similar findings. Over the 1, 3, 5, and 10-year periods ending Dec. 31, 2021, the tactical funds had lower returns and greater variation of returns than the universe of strategically allocated funds.
A 2021 study done by Kanuri, Malm, and Malhlotra published in The Journal of Index Investing, “Is Tactical Asset Allocation a Winning Strategy?,” concluded: “Tactical allocation mutual funds underperformed all benchmark indexes and had lower absolute and risk-adjusted performance from January 1994 to October 2016. Investors would have been better off with passively managed funds that followed benchmark indexes.”
Market timers will sometimes defend market timing by pointing to the many how-to books and newsletters written by other market timers, as though the weight of their words and the shear number of their disciples somehow justifies the practice.
But the fact that there are many market prognosticators does not lend credence to their predictions. The Antoons article referred to above cites a study done by Graham and Harvey covering 237 market timing newsletters. From 1980 through 1992 less than 25% of the recommendations in those newsletters were correct.
What to Do and Why
David Swenson, former manager of the Yale Endowment Fund, stated: “Market timing explicitly moves the portfolio away from long-term market policy targets, exposing the institution to avoidable risks. … To ensure that actual portfolios reflect desired risk and return characteristics, avoid market timing and employ rebalancing activity to keep asset classes at targeted levels.”
Advisors should heed this sage advice and focus their efforts instead on preparing their clients for the inevitable bumps they will encounter on the way to their personal fields of clover. Clients are only harmed by bear markets if they are fearful and ill-prepared.
Between 1942 and the end of March 2023 there have been 15 bear markets and 15 bull markets. The average bear market lasted 11.5 months. The average bull market lasted 4.4 years. Average losses from bear markets were a cumulative -30.9%. Average gains from bull markets were a cumulative 155.7%. The pain of bear markets is real but relatively short-lived.
Advisors can earn their fees by preparing their clients for the reality of what it takes to achieve the 11.72% annualized return mentioned in David Leo’s newsletter. That involves training them to tune out those who would have them believe that there is a magic way to avoid the market’s downside without also giving up its bountiful returns.
Scott MacKillop is CEO of First Ascent Asset Management, a subsidiary of GeoWealth, LLC. He is an ambassador for the Institute for the Fiduciary Standard and a 47-year veteran of the financial services industry. He can be reached at [email protected].