The Hindu Business Line : Market timing, a utopian possibility

Timing the market is essentially the art of predicting the future direction of the market through the use of technical and fundamental indicators. Some investors switch between asset classes and funds in an attempt to profit from the changes in their market outlook.

Just within the ambit of equity investing, market timing involves high risk and achieving anywhere close-to-best case outcomes is next to -impossible. Unless of course, an investor gets massive slices of luck.

Let us consider two investors, Mr Happy and Mr Glum — the former investing systematically and the latter based on market timing. The investments are made in Sensex since 1979 and the value is reckoned on December 2008.

The fact is that the compounded annualised returns of both the investors arrive at almost the same value. This clearly shows that the effort taken in timing the market is necessarily a futile exercise; the risks are significant even as returns are almost similar and outcome, to understate the case, is almost unlikely. The risks are only on the downside.

Methodology

Mr Happy: Investment of Rs 1,000 on either the 1st or 5th or 10th or 20th of every month without bothering about any other aspect except personal exigency. His total investment in a year is Rs 12000 on each specific date

Mr Glum: One market-timed investment of Rs 12,000 every year. His investment is made every year on the basis of one of two specific dates in a year: the lowest Sensex value day or maximum loss day of the Sensex.

Investment is made every year since 1979. Each investor has deployed Rs 3,57,000 as on December 2008. Mr Happy ends the year with Rs 54,69,597 (certain outcome) and Mr Glum with Rs 60,23,560 (almost impossible outcome).

When we calculate the compounded annualised growth rate of their investments and take the average of them, we arrive at 15.04 percent for Mr. Happy and 15.41 percent for Mr Glum.

Here we find the average annual returns of both the investors are almost similar. Even after taking the effort of timing the market and investing Rs 12000 in a year, Mr Glum has achieved only a marginally higher return than what Mr Happy has got, by investing Rs 1,000 every month systematically without any exertion.

Though the return arrived is similar for both the investor, the risk taken to arrive at the return is higher in the case of Mr Glum. This shows the risk-adjusted return being low for the Mr Glum.

The probability of correctly predicting each day of every year successfully for 29 years is statistically an almost impossible outcome.

For Mr. Happy, the risk is only in line with the market and no more and since the investment is done systematically the outcome is also certain and is also a very practical approach for every investor

(The author is Head, Products Team, Sundaram BNP Paribas Asset Management. Excerpted from ‘The Wise Investor’)

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