Buy And Hold Vs Market Timing – Pros and Cons of Timing Stocks
Buy and hold vs. market timing is a widely debated theme in the stock market. There are numerous articles on the internet arguing the futility of timing long-term investments. We decided to do some tests ourselves by removing just a few observations from the datasets to see what happens to the long-term compounding:
Buy and hold vs. market timing shows that you increase the risk of getting mediocre returns if you get it wrong. In general, market timing is a pointless exercise if you are a long-term buy and hold investor. Removing just a few of the best and worst days in the price series changes the end result dramatically.
Why is wrong market timing influencing the end result so much? Because of the compounding effect. This is what Warren Buffett calls Snowballing. If you get it right, you become a genius. If you get it wrong, you risk looking like a fool.
Is compunding the eight wonder?
Albert Einstein is famous for saying that compounding is the eighth wonder. But is he correct?
Yes, to a certain extent, he is correct. But Mark Spitznagel made some interesting calculations in his latest book called Safe Haven investing.
Spitznagel says multiplicative compounding is the most destructive force in the universe. In real life, the problem is that you can only traverse one path, not the average. If you don’t pick the right path, you might ruin your compounding ability for years and decades to come. If you get it wrong, the compounding effect is not to your advantage.
Recently, we showed why arithmetic and geometric averages differ in trading and investing by using Monte Carlo simulation. We recommend reading that article if you don’t understand Mark Spitznagel’s reasoning.
Is buy and hold a good strategy? Better than market timing?
If you want to participate in society’s wealth creation, you have to invest in stocks. It has proved to work very well for over a century although some countries went bust along the way, like China, Germany, and Russia, for example (and some others).
But even if your country does not default, you can end up with mediocre returns (even penniless) if you are unlucky with the sequence of returns. For example, those who invested in 2000 didn’t have any returns for over a decade. Currently, many young investors most likely have never e