

Visual proof that investors are bad at timing the market - jonxu
http://blog.futureadvisor.com/visual-proof-that-investors-are-bad-at-timing

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hesitz
Where is the link between the graphical analysis (investors as a whole are bad
at timing the market) and the subsequent quotes, (e.g., Bogle saying "I do not
know anybody who has done it successfully and consistently. . . .")

It is a far cry from knowing that investors _as a whole_ don't market time
well, but that has nothing to do proving that some skilled specific investors
might not be good market timers.

For the record, I do think there's evidence out there that does show that even
the "best" market timers succeed largely because of chance or luck, but it's
not something you can get to from the data offered here. Because there are
individuals who do succeed at timing the market. The question is whether they
succeed due to skill or luck. . .

~~~
bolu
They're both part of the same story: that individual investors are bad at
this, and professional managers aren't any good at it either.

Fair point though, that was definitely a conceptual leap of some distance
there between the two.

The skill vs. luck argument is actually better investigated by looking at a
separate data set: that of the persistence of performance over time for the
same manager. We'll do a story about that sometime in the future.

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noname123
How does outflow of capital from one asset to another measure investor's
ability at timing the market? Yes, one pulls out on equity if one predicts
that S&P500's going to drop but most of times decisions are made based on the
volatility and risk tolerance. A retirement fund with a closer retirement date
or income/growth fund will pull out if they find the risk/volatility level of
the general market to be unacceptable.

A better measure of investor's ability to time the market is the performance
of hedge funds as by its nature, the traders trades both sides of the market
and performance is measured by their ability to predict both downward and
upward trends.

~~~
bolu
Good data for the performance of hedge funds as an asset class that account
for survivorship bias is somewhat hard to find. Off hand, Swensen in
"Unconventional Success" recounts that for a single decade period that he was
looking at, third quartile managers matched the market before fees. So after
the standard hedge fund fees investors in those funds underperformed the
market by about 1.6% (in his specific decade-ending-dec-2003 time series
example).

Looking backwards, you can always identify fund managers that beat the market,
but only in hindsight. One big part of this that's left unsaid is that yes
it's possible to find managers to beat the market in hindsight, it's finding
these managers ahead of time that's difficult & unlikely. Coupled with how
much you'll trail the market if you try and don't succeed in finding
outperformers ahead of time, it's a bit of a losing game to try.

There's an entire other field of study about the persistence of performance,
but suffice to say that looking in the rearview mirror for last decade's
outperformers doesn't help you find the next decade's outperformers.

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jonheller
And how are those folks faring who didn't time the market for the past decade?
On average, their funds are at the exact same place they were in 2001.

I work for a company (who I won't mention simply because I don't want it to
appear that I'm shilling for them), who has used market timing since 1972 and
over the past 40 years have consistently outperformed the market using three
fairly simple market timing indicators. Not by leaps and bounds - generally
just a few percentage points - but still outperforming.

~~~
bolu
Thats true, but we must remember that for folks who _did_ try to time the
market many will have actually had negative returns because of failing timing
attempts. For example, there was a massive outflow of funds from Equities
after the most recent correction (as there usually is when the market performs
badly), and those people who pulled out of equities did not get to participate
in the record-setting rebound that happened soon after.

Comparing performance over any given time period to some arbitrary standard
(in this case, "flat" is assumed to be bad) doesn't tell the whole picture. On
the flip side, there are many instances where funds performed admirably but in
a time when the markets as a whole did even better. Just as I wouldn't commend
a fund for gains in a bull market, docking a fund or portfolio for being
"flat" when the market as a whole was flat over the given time period is
unfair.

I don't doubt that your company has outperformed (after all, you have the data
and I don't). But for what it's worth, was it a slam dunk to assume 40 years
ago that your company would have outperformed over the subsequent 40 years?
That's the problem: picking winners before they're winners. Will you
outperform for another 30 years (my own investment horizon?). Hard to tell.

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gojomo
Er, every transaction has both a buyer and a seller – both of whom are
investors. If one is timing well, the other is timing poorly – summed over
both, the class of all 'investors' can never be winning or losing from timing.
Only subsets of investors could.

~~~
bolu
Because we used the inflows & outflows of a couple large retail mutual funds
as proxy for investor demand, you're right that the story actually is "retail
investors are bad at timing the market".

There's a whole other set of data to dive into whether or not professional
managers as a whole are bad at market timing (spoiler: they are terrible at
it), but you're right in that this is not what this data set addresses.

Really the point the article is making is that on the whole, you and I, the
investing public, shouldn't try to "read the tea leaves" and pull our money in
and out of the market / move money around in the market because of what we
believe will happen in the near future. What this data proves is that this
doesn't actually work.

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jpdoctor
Sounds like BS:

> _On the x-axis we show the flow of capital into an asset class_

For every buyer, there is a seller, so every single transaction nets out to
exactly $0 flowing into the asset class. So exactly how does capital "flow"
into or out of an asset class?

You would guess that they are confusing the change in valuation, but that is
what they are using for the other axis.

~~~
noname123
You sell your stocks (asset class: equity) and someone buys it and gives you
cash; then you go and buy treasury bonds (equity class: government bonds).
Money flow out of equity into U.S treasury, otherwise known as "flight to
safety."

~~~
jpdoctor
> You sell your stocks (asset class: equity) and someone buys it and gives you
> cash;

OK, let's write it out:

Before

    
    
      Person1:  Has $100 cash.
      Person2:  Has equity worth $100
      Person3:  Has Tbond worth $100
    

After "you sell your stocks"

    
    
      Person1:  Has equity worth $100
      Person2:  Has $100 cash.
      Person3:  Has Tbond worth $100
    

After "you go and buy treasury bonds"

    
    
      Person1:  Has equity worth $100
      Person2:  Has Tbond worth $100
      Person3:  Has $100 cash.
    

Now quantify the "money flow" for us.

~~~
noname123
I realize that I didn't explain this part fully. Any asset aside from cash is
speculative - and is primarily determined by how much a person's willing to
buy and sell it for.

So when AAPL is worth 500 billion or whatever in one day, it doesn't actually
mean that AAPL can be converted into cash wholesale for $500 billion dollars -
it means that for that particular day, the small percentage of trading
involving AAPL shares determined that people were willing to pay for XX amount
of dollar/share for the stock and multiply that by number of outstanding
shares => we get the market's valuation of AAPL at that particular moment of
the market's condition of supply and demand. However, in the hypothetical
scenario in which Steve Jobs foundation owned 100% of AAPL and decided to have
estate-sale, the market dynamics of dumping all shares of a stock onto the
market is equivalent of oversupply of the stock to sell and not enough buyers,
and therefore driving the stock price down.

So suppose in the "flight to safety" scenario, the equity market is shaky for
whatever reason: unrest in middle east, euro crisis etc. The demand for equity
is less, therefore what I paid originally for SPY (S&P500 tracking index) may
be $100, but the highest someone who wants to buy it from me might be $80. But
I sell it anyways because I'm driven by fear that the market's going to
deteriorate further. With that money, I have only $80 worth of buying-power.

On the flip-side, as everyone's getting out of the equity market, they rush to
the government bonds market as this is the safest investment. The demand for
treasury bills suddenly goes up, therefore to buy your bonds; you have to be
willing to buy them at a higher price than the next guy. So if I want to buy
the same number of bonds previously of value $100, I have to spend now $120.
So you see how now the bond market taken at wholesale is valued more.

So in your scenario, flight of safety goes like this:

Person 2: Sells equity of original value of $100 for $80 to person1

Person 1: Then has equity valued at $80 at the time

Person 2: Buys $80 worth of bonds from person 3 and now has Tbond worth $80

Person 3: Sells bonds of original value of $100 for $120; a portion of which
goes to person 2

~~~
alok-g
Thanks for the explanations!

So how would you now quantify money flow with your example?

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PaulHoule
if investors were good at timing markets, you wouldn't need to time the market

~~~
bolu
Indeed - yet individual investors try anyway, and the futility of this is all
we're trying to point out.

~~~
dfragnito
You should point this out to <http://wealthmagazine.com>. They have a service
they sell, where they train you on how individuals can time the market. You
take a course they offer then buy into their online tool and start timing the
market like the big boys. The course is all about how to effectively use their
tools.

I went to a seminar that had some big names, Terry Bradshaw, Colin Powell,
Gulliani, Bill Cosby. It was very entertaining and basically free. In between
the speakers they sold you really hard on various things. Wealth Magazine had
what I feel was the most aggressive sell.

They did the standard look at this 69 year old women who has consistently beat
the market. If she can do it so can you. Well if I put 20 million monkeys in a
room there will be a few who consistently beat the market.

This is the basic pitch

Their tools will show you where the big boys are moving their money. Because
they are constrained by certain covenants they cannot move their money fast
enough, but you can. When you see the money start to move out of one asset
into another jump on it. The tool will also tell you if a stock is under
valued (I guess no one else has this data so it stays undervalued?)

They made a killing that day. As I am sure they do in all of these events.

~~~
bolu
You've pointed out the exact nature of the problem. They made a killing that
day, and they probably will continue to make a killing as long as naive
investors believe they can beat the market (whether with timing, or security
selection, or both).

The only way around this is to educate investors about things like this.
Because let's be honest: those guys at Wealth Magazine (at least the ones
running the place, I presume) know full well their customers are wasting their
money. But the fact is, it's revenue for them, and as long as that spigot is
still flowing no way are they going to bite the hand that feeds them.

It's a conflict-of-interest situation, rather than a lack of knowledge on the
part of the folks selling these financial services. You can be sure the guys
(and they're usually guys) at the top aren't buying funds based on advice from
Bill Cosby (no offense to the actor's other skills).

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nirvana
I believe this is testing a false premise. The premise is, that when investors
think the market is going to go up in the next month, they move money into
mutual funds, and that when investors think the market is going to go down in
the next month, they move money out.

I'm sure some proportion of investors move money in and out of mutual funds
based on their market expectations, but I do not believe they do so with a
single months time horizon, nor do I believe they are the majority.

I submit that a potentially quite large proportion of investors-- especially
in mutual funds-- are not doing this, but are instead moving money into those
mutual funds each month as a percentage of their paycheck goes into their 401k
or into their savings plan. Further, some large proportion is likely investors
moving from one mutual fund to another, while others are cashing out because
they retire, etc. I bet a check on your flow dates to see if its correlated
with an annual peak in employment change dates (e.g.: what month are people
most likely to retire, or change jobs?) might find some correlation.

Worse, if I'm reading it correctly, this plot shows the return of the asset
class over the course of a single month.

This means that you're assuming that these mutual fund investors are trying to
time the market on the scale of the expected return within a month. This seems
implausible to me given that mutual funds are managed and thus not well suited
for timing (a lot easier to time the earnings announcement of Google, for
instance, than guess what moves a mutual fund manager is going to make in a
particular month.)

I suspect that most investors who choose mutual funds have at least a years
time horizon, if not 5 years or more.

~~~
bolu
Your point about the single month as the timing period is definitely valid -
in hindsight the article would have benefitted from having that be maybe 6
months or 12 months instead.

The premise isn't as clear-cut as what you laid out, in my opinion. In general
people do start with the best of intentions; that is, their time horizon when
they buy is usually something like "until I need the money". But, that's the
generic case under stable market return conditions. In times of panic, folks
who thought they were okay with risk find out they're not okay with it, and
pull out (usually after much of the panic has already passed). In boom times
people start to, like you said, "move money between funds" usually in a way
that follows the recent price increases (gold recently, tech in 2001, etc).
It's these movements that the article is written against - and you're right,
it would have benefitted from a longer time series of returns.

Indeed, if you remember the oft-quoted Nasdaq Composite Index from the dot com
boom - the level in 1998 was the same level as in 2002, but in the interim
investors as a whole lost billions. That's a lot more than would have been
lost if people had just regularly been investing the same amount each month
into their 401(k), which is what we wish would have happened.

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publicus
Investors as a whole doesn't, but insiders like Goldman and the hedges
definitely does.

~~~
bolu
Active investors of all kinds definitely try, but again as a whole they've
failed. I'll try to dig up the data and put it into an article sometime, but
the fallacy that you should just pick a hedge fund and it'll outperform via
market timing or securities selection is false.

And of course, as for picking the "right" fund which will subsequently do that
- well that's the hard part.

