When “Professionals” Time the Market: A Case Study

One of the questions posed to any financial advisor requesting to advertise with us is a simple one.  “Do you believe you can time the market sufficiently well to beat a comparable low-cost index fund after
fees?”

It’s not a trick question, but some advisors feel they have to do better than the market average to provide value to their clients. And yes, some attempt to do this with market timing — buy low, sell high, and sit out of the market when things aren’t going so swell.

Spoiler alert: the answer we’re looking for on that vetting appication is a “No.” To time the market successfully, you have to be right twice, getting both in and out at the right times. Probabilities suggest that a number of people will get it right once or even multiple times, but reality has shown that almost no one can get it right consistently.

This guest post was submitted by Ryan Kelly of RFK Capital Management, a low-cost, flat-fee, fiduciary on our short list of recommended financial advisors. You can see his vetting application, including his answer to the question posed above, here.

In January 2019, I was talking with a friend and the topic of investing came up. She had recently been approached by a financial advisor while at work and opened a Roth IRA with that advisor.

(My friend, whom I will call Alice, approved this article for publication. All the names involved have been changed).

The financial advisor, whom I will call Rick, told Alice that his firm could help invest her retirement savings. Alice signed up for Rick’s help, but decided to tread cautiously and start with a modest $3,000 investment. As she became more comfortable with Rick’s approach to investing, she would consider having Rick and his firm manage more of her retirement savings.

Alice completed the necessary paperwork to open a Roth IRA at TD Ameritrade. She also signed a document that granted Rick’s firm with both trading authorization and the ability to withdraw advisory fees from the account. As Alice was reviewing the document, she asked how much she would be paying in fees. Rick replied “Just 1.9% per year.”

Alice deposited the $3,000 in mid-December of 2018.

Timing the Market

Alice asked me to take a quick look at her Roth IRA and offer my opinion on the investment portfolio. I agreed to do so. She logged into her TD Ameritrade Roth IRA on her phone and showed me the portfolio. I was bewildered to see that the account was 95% invested in bonds (with the rest in cash). The 95% bond allocation consisted of a single ETF: The First Trust TCW Opportunistic Fixed Income ETF (ticker symbol: FIXD).

Alice was 30 years old at the time and planned to work a full career. She had no debt, a sizable emergency fund, a substantial amount in 401k accounts, and was saving money to purchase a home. She was also comfortable with stock market volatility. I shared my view that she should at least have an 80% stock allocation. It made no sense that Rick had invested her Roth IRA in a 95% bond and 5% cash allocation.

I encouraged Alice to email Rick and ask why her account was invested so conservatively. Rick replied with an explanation and Alice forwarded it to me. Here is part of Rick’s email reply. Please note I have removed the name of the research firm involved:

“Let me address the bond fund question. Our firm uses the research and management/direction of a multi-billion dollar client base. More about [the research firm] is found at ____________. They [recently] went to the bond fund you see in your account. That is not where they will stay. The market is still trading below its 200 day moving average so they have stayed out of the market but if it continues its upward trend it will signal a move back into equities.”

Before Alice wrote her initial email to Rick, I also encouraged her to ask him about the long-term impact of the 1.9% per year advisory fee being charged on her account. This is what Rick wrote as an explanation:

“When it comes to professional money management the idea is that with care and management that we will get a better net of fee, return then by just dropping it into an index fund and letting it go. Time can only tell though because of course we can’t guarantee that, just that the research supports it.”

I did a Google search and found the website of the research firm that Rick’s firm was using for advice on timing the market. The firm was led by a group of highly educated investment professionals. A number of them had achieved the prestigious Chartered Financial Analyst (CFA) designation. They were “professional” market timers.

After reading the email Alice had forwarded to me, I called her on the phone. I expressed my bewilderment that Rick and his firm were implementing a “market timing” strategy with her retirement savings.

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Quotes on Market Timing

I quickly explained the concept of market timing to Alice. I expressed my view that market timing was dangerous and based entirely on speculation. I read to her some quotes on market timing from respected thought leaders in the investment world. The quotes included:

“Without a doubt, the most serious mistake individual investors make is trying to time the market. Neither individual nor professional investors are able to make consistently accurate calls on the direction of market prices. In fact, I have never known anyone who knows anyone who has consistently made accurate directional bets on either equity or bond prices.” -Burton Malkiel, Professor of Economics, Princeton University

There are two kinds of investors, be they large or small: those who don’t know where the market is headed, and those who don’t know that they don’t know.” -William Bernstein, MD

“If I have noticed anything over these last 60 years on Wall Street, it is that people do not succeed in forecasting what’s going to happen to the stock market.” -Benjamin Graham

I sent Alice some video clips of John Bogle, founder of Vanguard, talking about the timeless principles of long-term investing success. It didn’t take long for me to convince Alice that buying and holding the entire market is pure investing, and timing the market is pure speculation. I soon helped Alice open a Roth IRA on her own and offered advice on her other investment accounts. She quickly became a DIY long-term investor using a simple portfolio of low-cost index funds.

29 Month Test

Although Alice decided not to give Rick additional retirement savings to invest, she was genuinely curious to see if it was possible for Rick’s firm to successfully time the market. She wanted to put them to the test. Maybe the “professionals” could outsmart the market? Alice decided to keep her modest investment with Rick for two to three years.

In June 2021, Alice and I revisited her account with Rick. She told me that soon after we first spoke in January 2019, Rick had tried to convince her to rollover an old 401k (a six-figure amount) from a prior employer to a rollover IRA managed by Rick. The 1.9% advisory fee would still apply. Alice declined Rick’s offer.

I volunteered to do an analysis to help Alice determine if the market timing strategy had worked. I told Alice that she would need to send me the 30 monthly account statements for the 29 month period of December 31, 2018 to May 31, 2021.

After reviewing the statements, I realized my analysis would be simple and straightforward for three reasons:

1. First, there were no deposits or withdrawals for the 29 month period. This would make the investment performance easy to calculate. I wouldn’t need to worry about doing share based accounting to account for any deposits or withdrawals.
2. Second, the “risk on” portfolio was always the same three funds and always in the same allocation: 53% in a U.S. large-cap stock ETF (ticker symbol: FEX), 14% in a U.S. small-cap stock ETF (ticker symbol: FYX), and 28% in an international stock ETF (ticker symbol: VEU). Roughly 5% was consistently kept in cash.
3. Third, the “risk off” portfolio was always the same allocation: roughly 95% invested in a bond ETF (ticker symbol: FIXD) and the remaining 5% was kept in cash.

Determining if Rick’s market timing strategy worked required just two steps:

1. First, I had to calculate the return of Alice’s portfolio (the market timing strategy) over the 29 month period.
2. Second, I had to calculate what the return of Alice’s portfolio would have been had Rick simply invested Alice in the “risk on” portfolio for the entire period. This would have been a buy and hold strategy. If Alice’s account had a higher return than the alternative buy and hold strategy, then the market timing strategy added value. However, if the alternative buy and hold strategy had a higher return than Alice’s account, then the market timing strategy was ineffective and subtracted value.

The Results

To gain a clear understanding of how the market timing strategy played out, I decided to input the monthly balances from Alice’s account statements into a spreadsheet. This would allow me to generate a chart to visualize the 29-month investment performance.

Here is a chart showing the performance of Alice’s Roth IRA from December 31, 2018 to May 31, 2021 using the market timing strategy:

The account increased nearly 33% over the 29-month period. But how did this compare to the alternative buy and hold strategy?

I next calculated what Alice’s investment performance would have been with the buy and hold strategy. With the buy and hold strategy, Alice’s account would have been invested in the “risk on” portfolio for the entire 29 month period. As mentioned earlier, the “risk on” portfolio included: 53% in the large-cap stock ETF (ticker symbol: FEX), 14% in the small-cap stock ETF (ticker symbol: FYX), and 28% in the international stock ETF (ticker symbol: VEU). The remaining roughly 5% was held in cash.

Using historical share price data from Yahoo Finance, I was able to determine the total performance of the “buy and hold” strategy over the 29-month period. Please note that I used Yahoo Finance’s “adjusted” share price data that adjusts for any dividends and capital gains distributions.

Here’s the performance of Alice’s Roth IRA that used market timing (blue line) compared to the alternative “buy and hold” strategy (red line):

As shown, the market timing strategy was ineffective and subtracted value from Alice’s account. She would have been much better off had Rick and his firm avoided market timing and just stuck with the “risk on” portfolio for the entire 29 month period.

Alice’s account, using the market timing strategy, grew from $3,056 to $4,063 over the 29 month period. Had she just been invested in the “risk on” portfolio the entire period (buy and hold), her account would have grown to $4,920. After netting out the excessive 1.9%/year advisory fee charged by Rick’s firm, the account would have grown to $4,703–still trouncing the market timing strategy. Here’s a table comparing the performance of the two strategies. Please note that the buy and hold strategy is net of the 1.9% annual advisory fee:

Alice’s Roth IRA would have had much better performance had Rick and his firm avoided market timing and simply executed a buy and hold strategy.

What Happened?

Where did the market timing strategy go wrong? Interestingly, the account was invested in the “risk on” allocation 80% of the time or for 23 of the 29 monthly periods. It was only in the “risk off” allocation 20% of the time or for 6 of the 29 monthly periods. Unfortunately, for most of the six months in the “risk off” allocation, the stock market was rising rapidly and Alice’s account missed out on those gains.

From December 31, 2018 to March 20, 2019, the account was in bonds in the “risk off” allocation. During this period, the stock market had very strong returns. Since Alice’s account was in bonds it missed out on those strong stock market returns.

From March 20, 2019 until early March 2020, Alice’s account was in the “risk on” allocation. On March 4, 2020, Alice’s account switched to the “risk off” allocation in the middle of the Coronavirus stock market crash. This helped the portfolio initially as the market continued to crash; however, after the stock market bottomed on March 23, 2020, the portfolio continued to be on the sidelines in bonds even as the stock market aggressively rebounded. The account did not go back to the “risk on” allocation until June 5, 2020. On that date, the stock market (as measured simply by the S&P 500) was trading 42% higher than it had been just six weeks prior. Rick and the research firm missed a huge opportunity to get back into the market at favorable prices in late March of 2020.

One of the main criticisms made by Vanguard founder John Bogle about market timing is the need to be right twice. He said, “It is difficult to make even one timing decision correctly. But you have to be right twice. For the act of, say, getting out of the market implies the act of getting in later, and at a more favorable level.”

Market Timing vs. 80% Stock Allocation

I showed my analysis to a fellow financial advisor. He felt a better “apples to apples” comparison would be to compare Alice’s account performance to an 80% stock and 20% bond allocation. His logic was that Alice’s account had been in bonds for 20% of the period (6 out of 29 months). Thus, it shouldn’t be compared to a 100% stock allocation; it should be compared to an 80% stock and 20% bond allocation.

We determined that the Vanguard LifeStrategy Growth Fund (ticker symbol: VASGX) was an appropriate benchmark because the fund maintains a fixed 80% stock allocation. It also has 30% of the fund invested in international stocks; that’s roughly the target international stock allocation of the “risk on” portfolio for Alice’s account managed by Rick.

The 80% stock allocation as measured by the Vanguard LifeStrategy Growth Fund still trounced Alice’s account performance over the 29 month period, as shown in the table below:

A Golf Analogy

I presented my findings to Alice and she was stunned to see how much value had been subtracted because of the market timing strategy. She decided to transfer her Roth IRA managed by Rick to a self-managed Roth IRA invested in a buy and hold strategy using a simple portfolio of low-cost index funds. She is convinced that market timing is speculative and a bad idea. She has bought into a “principles based” investing strategy that focuses on asset allocation, broad diversification, low costs, and long-term focus, and discipline.

One could argue that 29 months is a short time period to definitively conclude that the research firm (that offered advice for Alice’s account) is bad at market timing. I recognize that a 15 to 20 year time period would be ideal.

As I pondered this, a golf analogy came to mind. Let’s say you play a round of golf at a local golf course and are paired up with a stranger. On the first tee, you engage in small talk with the fellow golfer and he tells you he plays professional golf on the PGA Tour. You are impressed and are excited to play a round of golf with him.

On the first hole, the alleged PGA golfer gets a triple bogey. On the second hole, he gets another triple bogey. On the third hole, his drive slices into another fairway.

As you are walking to your next shot, you seriously question the golfer’s claim of being on the PGA Tour. Yes, it may be within the realm of possibility that he’s just had a rough start and will play the rest of the round under par. But most likely, the stranger is just a fellow hack golfer.

The research firm is making a claim of “superiority over market averages.” However, based on the first 29 months of performance in Alice’s account, that seems to be a false claim.

Lesson Learned

Many in the Physician on Fire community believe that the biggest problem with hiring a financial advisor is the risk of being charged excessive fees. I certainly agree that’s a big problem, but I believe another big problem with hiring a financial advisor is the risk of being put into a suboptimal investment strategy.

Likewise, many in the Physician on Fire community believe that the greatest value-add of becoming a DIY investor is the huge cost savings over an investment lifetime from avoiding advisory fees and sticking with low-cost index funds. I certainly agree that’s a big value-add, but I believe an equally important value-add is knowing that you are following a time-tested and evidence-based strategy of buying and holding low-cost index funds over an investment lifetime.

Financial advisors have historically built their value proposition on an “investment-centric” basis. This has led many financial advisors to believe that they need to “beat the market” to add value to their clients. This endeavor usually leads to poor investment outcomes. Good financial advisors are fully satisfied with market returns and help their clients be satisfied with market returns too.

I believe that the index fund is the most important financial innovation that has been created for the individual investor. To fully capture the long-term benefits of indexing, one must decide on a reasonable asset allocation, stay the course, and focus on “time in the market” rather than “timing the market.”

There’s no need to attempt to time the market. To quote John Bogle “Don’t do something, just stand there.”

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