Market Timers Are Bound to Fail Trying to Predict Broad Swings : Investing: Recent turmoil has some fund shareholders wondering if the long-awaited bear market has arrived.

The recent turmoil in the stock market has some fund shareholders wondering if the long-awaited bear market has finally arrived.

Many will try to outmaneuver the markets by shifting assets out of stock funds and into money market funds or bank accounts. They might succeed in dodging the bullet this time, but any strategy that depends upon an investor’s ability to outguess the stock market is bound to fail in the long run.

The evidence is overwhelming that market timing--shifting money between stocks and other assets in an attempt to ride bull markets and avoid bear market losses--simply doesn’t work.

Consider the records of funds that pursue a timing strategy. Henry Van der Eb, manager of the Mathers Fund (800-962-3863), became bearish on the market in early 1989, and moved to a largely cash position.

As a result, the fund has delivered an annualized average return of only 5.84% over the past five years--compared with 13.70% for the S&P; 500.

“When you ask investors who have been successful over time, they’ll tell you that their record has nothing to do with market timing,” says Roger Gibson, a Pittsburgh money manager and author of Asset Allocation (Irwin Professional Publishing, $45).

Such anecdotal evidence has been strongly supported by academic and other formal studies over the years. Those studies generally conclude that the odds are heavily against a market timing strategy; over the long run, you are more likely to make money by sticking with your stock holdings through thick and thin.

Why? Because over periods of three to five years or longer, stocks are wonderful investments--far better than cash or anything else you can buy through a mutual fund. Thus, whenever you take money out of stocks you are probably going to pay a penalty in the form of lower long-term returns.

Of course, there are times when it pays to be out of stocks.

But such times are more infrequent than most investors realize. Gibson cites a 1987 study by Trinity Investment Management, which reviewed bull and bear markets over a 40-year period.

The results included these findings: 1) Bull markets lasted nearly three times as long as bear markets--41 months versus 14 months. 2) The typical bull market delivers a 105% gain, versus a 28% drop in the typical bear market. 3) Even during bear markets, stocks go up during three to four out of every 10 months.

The Trinity study is almost seven years old, but its conclusions would be even stronger today, as stocks have advanced steadily during most of the intervening period.

To succeed as a market timer, you must not only miss bear markets, you must also be sure and get back into the stock market in time for the next sustained rise in share prices. But those rebounds often occur after sharp declines in stock prices--the very times when most timers are still scrambling to get out of stocks.

Also consider taxes and transaction costs. A study by Mark Hulbert, editor of the Hulbert Financial Digest, looked at pre- and after-tax returns of the recommended strategies of 29 market-timing newsletters and compared them with the returns of an index fund that invested in the S&P; 500.

On a pretax basis only four of the letters beat the index fund over five years. After taxes were considered, only one newsletter edged out a buy-and-hold strategy.

So what should you do if you’re worried? Make sure your savings include three to six months of living expenses in cash investments so you can cope with unexpected expenses or a financial setback such as a job loss. Also consider shifting some money from more aggressive funds to conservative growth funds.

The Crabbe Huson Equity Fund (800-541-9732), for example, has been only 41% as risky as the average equity fund over the past three years, but has delivered 24.2% annual returns over the period. The fund’s management team uses a contrarian approach, choosing battered stocks whose shares aren’t likely to decline as steeply as the typical stock in a bear market. The fund has no initial sales charge and a $1,000 minimum initial investment.

Another conservative choice is T. Rowe Price Capital Appreciation (800-638-5660; no load; $2,500 minimum investment). The fund has been only 27% as volatile as the typical growth fund during the past three years, but has delivered 14.7% annual returns, comparable to the S&P; 500’s 15.3% annualized gain.