Six months before he died, the legendary investor Benjamin Graham gave an hour-long interview at his home near San Diego to a financial analyst called Hartman L. Butler, Jr. Thankfully, Butler recorded the interview for posterity on a tape recorder, and the resulting transcript makes for fascinating reading.

It was March 1976. Graham, who was 81 at the time, was widely known as the "father of value investing." His principles had profoundly influenced notable investors such as Warren Buffett. Yet what comes over most strongly from the interview is that, in his later years, Graham's views on investing appear to have changed.

Far from encouraging people to engage in detailed security analysis, as he did for most of his career, Graham advocates in his interview with Butler for a more straightforward approach. Most investors, he suggests, including institutions, should invest in index funds rather than individual stocks.

"The efficient market people have kind of muddied the waters, haven't they?" Butler suggests, referring to the hypothesis, famously championed by Eugene Fama at the University of Chicago, which states that prices fully reflect all available information.

Graham replies: "Well, they would claim that if they are correct in their basic contentions about the efficient market, the thing for people to do is to try to study the behavior of stock prices and try to profit from these interpretations." In other words, Graham was saying, instead of picking stocks, investors may instead be tempted to time the market instead, or try to buy and sell at the right time. But Graham made it clear it was not a course of action he would recommend.

"To me," he went on, "that is not a very encouraging conclusion because if I have noticed anything over these 60 years on Wall Street, it is that people do not succeed in forecasting what's going to happen to the stock market."

  

"A Wicked Idea"

Graham is certainly not the only well-known investor to caution against market timing. Fama himself referred to it as "a flimsy, dangerous occupation." Charles Ellis, in his book Winning the Loser's Game, calls it "a wicked idea." Ray Dalio, the billionaire hedge fund manager, said in an interview in January 2022 that timing the market is harder "than competing in the Olympics."

So why is profiting from market timing quite so challenging? There are several reasons. For example, it's very hard to keep making the right calls with any consistency. You may, for example, succeed in getting out of the market before it falls heavily, but, to profit from it, you also need to time your re-entry correctly, and that is arguably even trickier.

Another reason for avoiding market timing is that, even if you make more good calls than bad (and most investors don't), the profits you make are not necessarily worth the risk. In a 1995 article, 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%. Had you 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.

You Can't Predict the News

But surely the most important reason not to time the market is simply that you can't predict the news. Indeed nobody can. Just try watching the headlines at the start of tonight's TV news, and then ask yourself this: How many of these stories could I honestly have predicted when I woke up this morning?

Of course, everything seems so obvious with the benefit of hindsight. But predicting, say, the result of an election or a referendum ahead of time is anything but. It's the same with interest rate announcements. Remember, too, that most of the big news events that have occurred over the last 25 years came almost completely out of the blue — the 9/11 terrorist attacks, the 2008 financial crisis, and the COVID-19 pandemic, for example.

So why is the fact that predicting news events is all but impossible so critical? Well, it's news that causes stock markets to rise and fall.

In Step 4 of his book, Index Funds: The 12-Step Recovery Program for Active Investors, explains this point by way of the illustration below, called Market Forces.

Three Key Variables

"The model shown in the Market Forces painting," writes Hebner, "attempts to diagram the three variables of uncertainty, expected return, and price — resulting in a distribution of realized monthly returns shown at the bottom. The illustration shows the essentially constant expected return of an investment held constant with a highly diversified portfolio of 50 percent stocks and 50 percent bonds.

"The constant flow of current news creates a level of economic uncertainty and is represented on the left side of the teeter-totter. This economic uncertainty includes the probabilities of future events as estimated by the buyers and sellers. The price agreed upon by willing buyers and sellers is on the right side, and it represents that level of uncertainty. Prices move inversely proportional to shifts in economic uncertainty so that expected returns remain essentially the same for a given level of risk."

In other words, at any one time, some commentators may consider the market to be undervalued, others may say it's fairly valued, and others may warn that it's overvalued and due for a crash or correction. But the most logical way to look at it is that prices are fair in that they reflect the very latest best-guess estimate of the entire market as to how much each individual security is worth.

In short, because prices are fair, investors should expect a fair and risk-appropriate return. It may be a higher return, but there's an equal chance that the return will be lower. And the farther the realized return is from the expected return, the lower the probability of its occurrence.

"Investors," Hebner concludes, "should not try to forecast the direction of the market because they don't know the next news story. There is no competitive edge that exists other than illegal inside information. The best way to earn the market's fair return is to simply remain invested at all times in a relatively low-cost, passively managed index portfolio."

 

All You Have To Do

Here's a thought to end on. A few months after Benjamin Graham gave that interview to Hartman L. Butler, Jr, and just three weeks before his death, the first S&P 500 index fund available to individual investors was introduced by John Bogle, the founder of Vanguard.

Over the intervening 48 years, the S&P has fallen sharply many times. Nevertheless, say you invested $100 dollars on day one and just left it there, resisting the temptation to time the market, how much would it be worth today? At the time of writing, the answer is around $12,890.

Just think about that. You didn't need to beat the market to earn that return — that was the market return. You simply had to stay invested. And that's all you have to do now. No, it's not always easy to stay invested — that's one of the reasons why investors need advisors — but it's simple and effective.

As Graham himself wrote in his book The Intelligent Investor: "The best way to measure your investing success is not by whether you're beating the market but by whether you've put in place a financial plan and a behavioral discipline that are likely to get you where you want to go."

Do you have such a plan? And do you have the discipline required? If the answer to either of those questions is No, get in touch. We're here to help you.

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ROBIN POWELL is IFA's Creative Director. He always works as a freelance journalist and author, and as Editor of The Evidence-Based Investor.

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