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Timing the market: Is it a good idea?

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You may be familiar with the adage that "time in the market beats timing the market." Many investors—and investment advisors—advocate for the idea that a buy-and-hold strategy is more advantageous in the long run than continually buying and selling based on market predictions.

Both tactics have their benefits and risks. Ultimately, whether it's a good idea to time the market depends on your risk tolerance and financial goals as well as your experience and interest.

To help you decide if it's a strategy for you, consider the process of market timing, its upsides and downsides and how it compares to the traditional long-term approach of dollar-cost averaging.

What does it mean to time the market?

Market timing is a strategy in which an investor tries to predict the future movements of financial markets, such as the stock market, with the goal of buying and selling assets at the most opportune times to maximize profits. The goal is to buy low, sell high and achieve superior returns.

Success in timing the market generally involves a lot of expertise and involvement, focusing on these main aspects:

  • Analysis and forecasting. Market timers use various techniques to analyze historical price data, economic indicators, financial news and other factors to predict the future direction of asset prices. Technical analysis, fundamental analysis and sentiment analysis are some common approaches.
  • Entry points. Based on their analysis and forecasts, market timers try to identify the optimal moment to enter the market or specific investments. They aim to buy assets when they expect prices to rise significantly in the future.
  • Exit points. Similarly, market timers look for the best opportunities to exit their positions and lock in profits by selling investments before prices decline.
  • Active management. Market timing is an active investment strategy that requires constant monitoring of markets and frequent adjustments to investment positions based on changing forecasts.

Since no one has yet proven to be able to accurately predict the future, this strategy is generally discouraged for most investors.

Potential advantages of timing the market

Timing the market is a highly debated topic in the world of investing. While it has potential benefits, they come with significant risks. Here are some of the possible upsides:

You have the potential for higher returns

One of the main reasons investors attempt market timing is the potential to achieve higher returns. By buying assets when they are undervalued and selling when they are overvalued, investors may be able to capitalize on short-term market fluctuations and generate above-average profits.

You can directly manage your risk exposure

Market timing can also be used as a risk management strategy. During periods of high market volatility or economic uncertainty, investors may reduce their exposure to riskier assets and move to more defensive positions.

You may be better able to preserve your capital

Market timing can be used to try to avoid major market declines. If an investor correctly anticipates a significant market downturn, they can sell their assets before the decline and potentially preserve their capital from substantial losses.

You can develop strong asset diversification

By tactically adjusting their asset allocation based on market conditions, investors can enhance their portfolio diversification. For example, they may choose to hold more cash or move to alternative investments during periods of market turbulence.

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Is dollar-cost averaging an effective strategy?

When it comes to investing, people can employ a variety of strategies to achieve success. The appeal of dollar-cost averaging is that it takes some of the emotion out of investing. Instead of trying to time the market, investors buy shares at fixed intervals regardless of market conditions.

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Potential disadvantages of timing the market

It's important to recognize that market timing is technically and emotionally challenging and comes with significant risks and limitations. Here are some to consider:

Variables make the market hard to forecast

Financial markets are influenced by a vast array of factors, including economic indicators, geopolitical events, investor sentiment and market psychology. Predicting how these variables will influence prices is complex and uncertain. Consistently predicting short-term market movements is extremely difficult. Even seasoned investors and financial experts often struggle to accurately time the market consistently.

Emotions may override your objectivity

Market timing requires making decisions based on predictions and forecasts, which can be influenced by emotions like fear and greed. Emotional decision-making can lead to irrational investment choices, stress and suboptimal outcomes.

Transaction costs can add up quickly

Frequent buying and selling of assets can lead to higher transaction costs, including brokerage fees and taxes, which can eat into profits.

You could miss out on long-term growth

Attempting to time the market can lead to missed opportunities if an investor is out of the market during periods of strong and sustained growth.

Dollar-cost averaging vs. timing the market

Dollar-cost averaging involves investing a fixed amount of money at regular points in time, such as monthly or annually, regardless of the asset's price. It naturally results in purchasing more shares when prices are low and fewer shares when prices are high. While dollar-cost averaging does not guarantee a profit, compared to timing the market, it's a more conservative, less stressful and more successful way to invest while trying to navigate market volatility.

Here are some of the ways the two strategies differ:

  • Reducing risk vs. potential for higher returns. Dollar-cost averaging reduces the impact of short-term market volatility and the risk of making poor timing decisions. That said, this approach may also mean you miss out on rapid market upswings. Successful market timing can lead to higher returns by taking advantage of short-term opportunities and by buying low and selling high.
  • Disciplined approach vs. emotional bias. Dollar-cost averaging encourages a disciplined investing habit by sticking to a regular investment schedule regardless of the market's behavior. By contrast, trying to time the market frequently induces emotional decision-making, which can lead to irrational choices that may or may not pay off.
  • Staying invested vs. missed opportunities. Dollar-cost averaging is a long-term, buy-and-hold approach that does not require making predictions. While this can eliminate the concern of missed opportunities, it can also leave you exposed to downside risk. Market timing can be used to reduce exposure to risky assets during uncertain times, potentially protecting capital during market downturns.
  • Saving on fees vs. paying for every transaction. Dollar-cost averaging involves a limited number of regular, planned transactions. Trying to get market timing just right, on the other hand, can mean a lot more transaction costs, which can take away from your overall profits.

Which is better: Timing the market or dollar-cost averaging?

There is no definitive answer as to which approach is better because choosing the right strategy depends on your risk tolerance, investment goals and time horizon.

For long-term investors with a low risk tolerance and a desire to avoid the stress of market timing, dollar-cost averaging can be a suitable approach. It encourages regular contributions and reduces the risk of making poor timing decisions.

More experienced investors who have the time, expertise and risk appetite for market speculation might find market timing appealing. However, it is essential to recognize that successful market timing requires accurate and consistent predictions, which are difficult to achieve.

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Deciding if timing the market is right for you

For savvy investors, timing the market can be a sharp tool to work with as you aim to make the most of what you have. But the hard-to-predict variables and potential for loss can feel intimidating.

Some investors choose a combination of strategies to strike a balance between discipline and opportunistic investing. That approach, as well as spreading your risk exposure across investment types, or diversifying your assets, may be one to consider as you build your larger financial plan. Partnering with a qualified financial advisor can help you make informed decisions that fit your goals.

Dollar-cost averaging does not ensure a profit nor does it protect against losses in a declining market. Because dollar-cost averaging involves continuous investing, investors should consider their long-term ability to continue to make purchases through periods of low price levels and varying economic periods.

While diversification can help reduce market risk, it does not eliminate it. Diversification does not assure a profit or protect against loss in a declining market.