How much do Marcoeconomic Market Timers lose to LTB&H investors?

Investment Analysis Clubs Macro Economic Trends and Risks
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Major financial research firms track the exact cost of this behavior gap by comparing standard index benchmark returns (buy-and-hold) against actual investor-level dollar-weighted returns (market timing). [1, 2]

Study / Source Timeframe Long-Term Buy-and-Hold Return Average Market Timer Return The Annual “Behavior Gap”
DALBAR QAIB Study 30-Year Period 10.65% (S&P 500) 7.13% (Average Equity Investor) -3.52% per year
Morningstar “Mind the Gap” 10-Year Period 7.40% (Average Fund) 6.30% (Actual Investor) -1.10% per year
RBC Global Asset Mgmt. 20-Year Period Balanced Portfolio Base Balanced Investor -3.10% per year
DALBAR (Volatile Year) Single Year (2024) 25.02% (S&P 500) 16.54% (Average Equity Investor) -8.48% (Single Year)

Why Market Timers Lose So Much Money

The math behind why active market timing fails boils down to a few inescapable factors:

  • Missing the Best Days: Stock market returns are highly concentrated. According to J.P. Morgan and Hartford Funds research, missing just the 10 best trading days over a 30-year window cuts your final retirement balance roughly in half. [1, 2, 3]
  • The “Right Twice” Requirement: To time the market effectively, you have to guess correctly exactly when to sell at the top, and exactly when to buy back in at the bottom. [1, 2]
  • The Closeness of Chaos: Historically, the absolute best single days in stock market history happen within days or weeks of the absolute worst days. Investors who panic-sell during a crash almost always miss the explosive rebound that follows immediately after. [1, 2, 3]
  • Friction and Fees: Every extra trade triggers transaction fees, management expenses, and short-term capital gains taxes that relentlessly erode your capital. [1, 2]

It’s just arithmetic.

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This is, of all arguments, the stupidest one. All you have to do is miss the 10 worst trading days and you will be far ahead, even if you miss the 10 best trading days. It’s just arithmetic.

Here: let me help:

October 19, 1987 (Black Monday): Plunged -20.5%
March 16, 2020 (COVID-19 Crash): -12.0%
March 12, 2020 (COVID-19 Crash): Fell -9.5%
October 15, 2008 (Financial Crisis): Lost -9.0%
December 1, 2008 (Financial Crisis): Dropped -8.9%
September 29, 2008 (Financial Crisis): Sunk -8.8%
October 26, 1987 (Black Monday Follow-up): Fell -8.3%
October 9, 2008 (Financial Crisis): Slumped -7.6%
March 9, 2020 (COVID-19 Crash): Dropped -7.6%
October 27, 1997 (Asian Financial Crisis): Lost -6.9%

Can you think of a lot of days when the market rose 10% in a single day? (Hint: Nearly all of them happened in the early 1930’s, as the Dow was whipsawed by the panic and subsequent volatility of traders trying to “cash in” before they realized the bottom had fallen out.)

Nah. You don’t have to get out at the top, nor in at the perfect bottom. You just have to miss the carnage.

Well duh. See: 1931 for the “best days” list. What a great time to have been in the market!

Only if you’re stupid.

It’s just arithmetic. And common sense.

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People have been telling me that for 40 plus years, yet my account balance says different.

I guess we’re all entitled to our own arithmetic. {{ LOL }}

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The problem is picking either the 10 best or the 10 worst. I asked Gemini to generate a list of financial news headlines from March, 2009:

“How Low Can Stocks Go?” — The Wall Street Journal (March 9, 2009)

“Citigroup Bailout Looming as Losses Mount” / “AIG Reports Record $61.7 Billion Loss, Gets More State Aid” — Reuters / BBC (March 2, 2009)

“As Markets Slump, U.S. Tries to Halt Cycle of Fear” — The Washington Post (March 4, 2009)

“U.S. Economy Loses 651,000 Jobs in February; Unemployment Hits 8.1%” — The New York Times (March 6, 2009)

“World Economy Likely to Shrink for First Time in Decades, IMF Warns” — The Guardian / IMF Report (March 10, 2009) Note: Global economic output had not contracted since WWII.

Okay, pretty bad time to buy stocks, right? Global contraction, job losses, stock market in free fall. Wrong. March 2009 was the start of the longest bull market in history. $100,000 invested in the S&P 500 at the worst, darkest time would now be worth $1.4 million (with dividends reinvested).

If you were reading METAR in early 2020 when COVID was emerging and it was clear the US government was in denial and unwilling to deal with the crisis, it seemed obvious it was time to bail. And several people did bail. Same thing, that was the time to jump in. I was still working and making regular investments. Instead of bailing, I bought Berkshire Hathaway on March 25, 2020 at $186.22. That investment is now up +177.30%. Almost tripled my money in just over six years. I’ll take that.

The American Nobel-prize winning economist Paul Samuelson did a seminal study in 1974 concluding most professional money managers do worse than the market average. That study lead directly to Jack Bogle (praise be his name) to create the low cost index fund.

Warren Buffett had a standing $1 million bet that a basket of five hedge funds could not beat the S&P index over a ten year period. He only had one taker (which leads one to wonder why there was such a lack of confidence in hedge funds) who then got soundly trounced by the index.

The jury is in. If you buy and hold the index you beat the vast majority of professional money managers and active traders. Keen observers will note that I bought an individual stock back in March 2020. Had I bought the index, I would be up +243%.

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And I consider BRK to basically be an index fund that doesn’t pay a dividend.

Of course, a lot of the difference between BRK and the S&P 500 is that BRK includes a big cash position.** It’s not a 100% stock portfolio like the S&P 500.

** over the past 30 years, BRK’s cash position has varied from a low of 10% of market cap to a current high of 35%.

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I’ve been wondering if the best stock market investing protocol might not be “Buy, buy, buy, and never sell. If a stock drops, don’t fret, let it go broke.”

So I asked AI…

This investing style is a real strategy that many people use. It is often called Buy and Hold or “Coffee Can” investing. The idea is to buy good companies and hold them forever, ignoring the ups and downs of the market. [1, 2, 3, 4, 5]

While this strategy can build great wealth, letting every falling stock go broke can sometimes hurt your wallet. Let us break down how this protocol works, the math behind it, and the hidden risks. [1]

Understanding the Strategy

When you buy a stock and never sell, you are acting like a true business owner. [1]

  • Compound Growth: Your money stays invested and can grow faster over time because you do not pull it out.
  • Lower Fees: You do not pay trading fees or broker costs for selling.
  • Tax Savings: You only pay taxes on investment profits (called capital gains tax) when you sell. By never selling, you delay these taxes for decades. [1, 2, 3, 4, 5]

The Math of “Letting It Go Broke”

Your idea of letting a bad stock drop to zero instead of panicking actually has some solid math behind it. This is due to asymmetric upside. [1]

  • Limited Loss: The absolute most you can lose on any single stock is 100% of the money you put into it.
  • Unlimited Gain: The most a stock can grow is infinite. A great stock can grow by 1,000%, 5,000%, or even more. [1, 2, 3, 4]

An Everyday Example

Imagine you buy 5 different stocks today, putting €1,000 into each one (Total = €5,000). You hold them for 10 years and never sell.

  • Stock 1: Goes broke. Value = €0 (You lost €1,000)
  • Stock 2: Goes broke. Value = €0 (You lost €1,000)
  • Stock 3: Goes broke. Value = €0 (You lost €1,000)
  • Stock 4: Stays exactly the same. Value = €1,000
  • Stock 5: Turns out to be a superstar company and grows 10 times bigger. Value = €10,000 [1]

The Final Result: Your total portfolio is now worth €11,000. Even though 3 out of your 5 companies went completely bankrupt, you still more than doubled your total money because of that one big winner.

The Hidden Risks to Watch Out For

While the math can work in your favour, “never selling” has a few major traps that can hurt everyday investors.

  • The Index Fund Advantage: If you try to pick individual stocks and they go broke, you lose that money forever. However, if you buy an index fund (a basket of hundreds of top stocks like the S&P 500), the fund automatically removes dying companies and replaces them with new, growing ones. [1, 2, 3, 4, 5]
  • Opportunity Cost: This is a fancy term for “wasted time and money.” If a company’s business model breaks, leaving your money in it while it slowly sinks to zero over 10 years means that money wasn’t working for you elsewhere.
  • Emotional Stress: Watching your hard-earned money drop to zero is highly stressful. Many investors say they won’t fret, but panic-sell at the very bottom anyway. [1, 2, 3]

How to Safely Use This Protocol

If you want to use the “Buy and Never Sell” strategy, you can protect yourself by following a few simple rules:

  1. Diversify: Spread your money across many different companies or industries. Never put all your eggs in one basket. [1, 2]
  2. Focus on Quality: Buy stable, profitable companies that have products people will always need (like food, healthcare, or major technology). [1, 2]
  3. Use Index Funds: The easiest way to “never sell” is to buy broad index funds. You can hold them forever, and the market filters out the failing companies for you. [1, 2, 3]

I agree with most of the above except:

  • The Index Fund Advantage: Funds have a lot of crap in them.
  • Opportunity Cost: The whole point is to get rid of emotions as much as possible.

Agree, but:

  • Diversify: But don’t over do it.
  • Focus on Quality: Use the Peter Lynch method, buy what you know.

Plus covered calls (maybe):

  • Every time you have a 100 shares of anything, sell covered calls.
  • Strike price at around Delta .3 to capture upside.
  • Roll up & out but never down & out.

The Captain

If only I were born again… alas…

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You don’t let it go broke. You match the sale of winners with losers and laggards to fund your annual withdrawals for living expenses with a zero tax liability. Over 20 or 30 years, you end up with a portfolio of mostly compounded, unrealized capital gains, with a thin slice of your original, tax-paid cost basis. Eventually you run out of losers to match with the winners.

My Avis short squeeze windfall in April was a $480,000 long-term capital gain with an $8,000 cost basis on stock I bought in 2002.

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The problem with the argument the clock is not starting in 1999, 2007, or 2026. In fact those years are used to enhance the results.

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No. Terrific time to buy stocks. I sold out before Bear Stearns went upside down in March 2008. I was out during the carnage. Completely out, except for some Berkshire bought in the early 90’s on which I already had big gains; otherwise we were totally in cash.

2009, despite the headlines, was a terrific time to come back in. I didn’t rush all of it in immediately, but the headlines didn’t scare me; that’s the “press reporting history ”, not looking forward. If you looked at what Obama and Congress were doing, they were making the right moves: interest rates, saving important sectors with bailouts, etc.

There was no one in government doing the Andrew Mellon “liquidate stocks, liquidate labor” dance. The best gains of my investing career were during the dot.com run-up, but the second best was probably this period as the market grew slowly - but to the sky. (I did interrupt the success by getting back out after the 2016 Presidential election, again n to totally but significantly, an error I have acknowledged and one for which I have no excuse.)

There’s “market timing” and there’s “market timing”. Short term I’d guess it’s a fool’s game, but maybe some can make it work. Over large, massive macroeconomic events (the pandemic collapse was another) it can work nicely for you.

People who complain it isn’t perfect don’t understand that you don’t have to be perfect. Nothing ever is.

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As a non-resident alien I don’t pay capital gains taxes and covered calls would take care of withdrawals. The problem with the match is that you might be selling long time rebound winners. The idea is to take out as much decision making as possible. Trading sucks!

The Captain

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I’m not trading. If your goal is to fund your expenses with long-term capital gains and tax paid returns of capital, you have to sell something.

That’s what I’m doing for my hour or two of annual “work” during the last week of the year when I do a little tax planning and decide how to fund next year’s expenses with the lowest tax liability possible.

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I’d have a 7 figure income tax bill if I did that. Maybe it works if you have everything in your IRA, but about 80% of my stock is in my taxable account. (Which is fine, since all an IRA does is convert what should be a long-term capital gain into ordinary income taxed at a higher rate when you make a withdrawal from a traditional IRA.

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Mine was decently into 6 figures - in the late 90’s. I had AOL in both my IRA and in our taxable account. I’m still glad I sold it.

I have to remind myself when I look at our IRAs “that isn’t really all ours. Uncle Sam gets some of it.”

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only if you are withdrawing amounts that put you in the higher tax bracket…quite a bit gets no tax or a lower rate.

But yes, I’d vastly prefer it if all the wealth I have in an IRA were in a taxable account instead. Oh well.

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