Catching the bottom requires three things: First, you must have a subjective feel for when stocks have reached their nadir and that the selling has reached its conclusion. Second, you must have conviction in your ability to do what nearly all investors cannot. And last, you must have the discipline to act on your beliefs, following your trading plan despite the mayhem that occurs near market bottoms.
If any of this were easy, people would nail the lows all the time, but we know they don’t.
The Costs: Do not forget that you have a partner in all of your trading: Uncle Sam. Even after the Tax Cuts and Jobs Act of 2017, capital gains taxes still exact a hefty premium for non-qualified (not tax deferred) accounts. This is a hefty price to pay for the small chance of getting the timing right.
Depending upon the length of your holding, your tax bracket and which state you live in, the government could end up capturing more than a third of your gains. The short-term Federal tax rate on capital gains can be as high as 23.8%; add in state taxes of as much as 13.3% and you quickly realize that Uncle Sam is more than a silent, junior partner.
This is a huge bogie to overcome. You don’t only have to get the top and the bottom right, but you must exceed the 20% to 30% “vig” on the transaction due to realized gains caused by the exit just to break even. If you had been riding the equity train since the Great Financial Crisis ended, that is an enormous amount of tax to pay for the mere chance to sidestep a downturn.
It turns out that most people are much better off merely riding it out than trying to time the market. Unless you have developed a secret formula that none of the Ph.Ds roaming Wall Street have been able to replicate that ensures being able to successfully move in and out of equities, do your future self a favor and stay away from market timing.
Barry Ritholtz is a Bloomberg Opinion columnist. He founded Ritholtz Wealth Management and was chief executive and director of equity research at FusionIQ, a quantitative research firm. He is the author of Bailout Nation.