Throughout our investing lives we are constantly tempted to act irrationally. A prime example is picking stocks. So, for example, we'll hear from our brother-in-law or a friend at work about a stock that's tipped to soar in price and instinctively want to buy it. Or we'll read in the papers about a fund that's vastly outperformed the market over the last 12 months and decide to invest in it.

Unfortunately, as Mark Hebner explains in his book, Index Funds: The 12-Step Recovery Program for Active Investors, picking stocks is a losing strategy. You're better off investing in the whole market, via low-cost index funds, instead. Trying to identify, in advance, funds that will outperform, is another fool's errand. In the long run, only a tiny proportion of active fund managers beat their respective benchmark on a properly cost- and risk-adjusted basis, and picking those very few winners before they start to outperform is all but impossible.

Another big temptation is to try to time the market. There are always pundits in the media saying that now is either a good time or bad time to invest in stocks or bonds, or in specific countries or sectors of the economy. Because of our evolutionary make-up, and particularly our desire to make sense of the world and to feel we have a degree of control over events as they unfold, we want to believe them. We're attracted by seemingly convincing narratives, and, because of our innate negativity bias, we pay a disproportionate amount of attention to pessimists and doomsayers.

The case against market timing

There are, however, three very compelling reasons why you should avoid trying to time the market altogether.

1. You need to be consistently right

At any one time, there is always some expert saying that markets are about to turn sharply, either up or down. Sooner or later, one of them is bound to be right.

Unfortunately, though, to benefit from market timing, you need to be consistently right. Even if, for example, you manage to get out of the market before it falls, you also have to decide when to get back in, and that can be even harder to do.

In a 1975 paper, the Nobel Prize-winning economist William Sharpe showed how a market timer must be accurate 74 percent of the time in order to outperform a passive portfolio at a comparable level of risk. Subsequent research has suggested that the real figure may be rather higher.

2. It's almost impossible to do consistently

Everything seems so obvious with the benefit of hindsight, but recognizing at the time that markets are in a bubble and about to crash, or that, after a long bear market, prices are finally about to rise again, is exceedingly difficult. Even the so-called experts are not very good at it.

In a 1996 study, John Graham from the University of Utah and Campbell Harvey from Duke University tracked 15,000 predictions made in investment newsletters published by financial institutions between June 1980 and December 1992. By the end of the period, 94.5 percent of these newsletters had gone out of business. Their average life span was just four years. "There is no evidence that newsletters can time the market," Graham and Campbell concluded. "Consistent with mutual fund studies, ‘winners' rarely win again and ‘losers' often lose again."

We shouldn't be surprised at how hard it is to call a market top or bottom. After all, current prices reflect all knowable information; it's new information that causes prices to move. "Investors should not try to forecast the direction of the market," writes Mark Hebner, "because they don't know the next news story. There is no competitive edge that exists other than illegal inside information."

3. Even if you succeed it makes little difference

OK, let's say you are a very clever (or lucky) market timer, and you manage to make several correct calls in a row. How much difference would it actually  make to your returns? Again, the answer is disappointing.

In an article written in 1995, the well-known fund manager Peter Lynch quantified the difference in returns a successful market timer would generate compared to an unsuccessful one. If you had invested the same amount of money at the start of every year for 30 years from 1965, Lynch explained, your return would have been 11% per annum. If you had been unlucky enough to have invested the same amount on the day the S&P 500 Index hit its peak for the year, your return would have been just 0.4% lower at 10.6%. If you had invested on the day the S&P 500 hit its low for the year, you would have returned 11.7% — just 0.7 more than if you had simply invested on every January 1.

Even perfect timing, then, made only a modest difference. "Whether your timing is good or bad," wrote Lynch, "what matters is that you stay invested in stocks."

What's the alternative?

In short, the odds of significantly improving your returns through market timing are heavily stacked against you. So how do you decide when the best time is to invest?

Charles Schwab addressed this question in a study published in September 2023. It analyzed the performance of five hypothetical long-term investors with very different investment strategies. Each received $2,000 at the beginning of every year for the 20 years ending in 2022 to invest in the S&P 500.

1. Peter Perfect was the consummate market timer and timed his investments perfectly every year.
2. Ashley Action invested her $2,000 in the market on the first trading day of every year.
3. Matthew Monthly divided his annual allotment into 12 equal portions, which he invested at the beginning of each month — a strategy known as dollar-cost averaging.
4. Rosie Rotten was the worst possible market timer and repeatedly invested at just the wrong time for the whole period.
5. Larry Linger constantly feared a market downturn so left his money in cash every year and never got around to investing in stocks at all.

The most interesting conclusion of Charles Schwab's study is that Ashley, who just got on and invested at the earliest opportunity, accumulated the second highest amount, $127,506, which is only $10,537 less than Peter.

In third place was Matthew, whose dollar-cost-averaging strategy netted him $124,248 at the end of 20 years.

Even Rosie Rotten's results were surprisingly encouraging. Despite her repeated timing "mistakes", she finished comfortably ahead of Larry in fifth place.

What the Schwab research shows, in other words, is that the best thing to do is to invest straight away.

What you absolutely shouldn't do is stay out of the market altogether, because even dreadful timing is better than inertia. In the long term, it's almost always better to invest in stocks — even at the worst possible time — than not to invest at all.

Interestingly, the Schwab researchers found that the results were remarkably similar regardless of the time period considered. They analyzed all 78 rolling 20-year periods dating back to 1926 (e.g., 1926-1945, 1927-1946, etc.). In 68 of those 78 periods, the rankings were exactly the same — in other words, Peter first, followed by Ashley, Matthew and Rosie, with Larry always last.

Of course, everyone is different, and there are some investors, particularly those prone to regret, who may feel uncomfortable investing a lump sum all at once. That's perfectly fine, as long as they realize that they will probably end up with lower returns.

Whichever you decide on, the key is to stay calm and rational, and in control of your investment decisions. Remember: although they don't always get it right, the financial markets do a pretty good job of valuing financial securities. You may think that markets are either undervalued or overvalued, but what they actually are is fairly valued, and you bet against them at your peril.

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ROBIN POWELL is a financial journalist and editor of The Evidence-Based Investor.

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