Guess what? All three portfolios would have returned 8.9 percent annually to investors since 1926. On that basis, the buy-and-hold portfolio is preferable because it requires the least work and results in the lowest transaction costs and taxes.
Few investors, however, have a 90-year investment period. So let's compress the time period.
When analyzed over rolling ten-year periods, the binary portfolio beats the buy-and-hold portfolio 47 percent of the time by an average margin of 1.9 percent, and loses by an average margin of negative 1.6 percent. The 47 percent success rate of the all-in-all-out portfolio reinforces the widely held belief that that version of market timing is, more often than not, a losing bet. When it fails, investors get slammed with severely subpar returns because the binary portfolio has all its eggs in the losing basket.
The tilt portfolio, on the other hand, beats the buy-and- hold portfolio 72 percent of the time by an average margin of 0.3 percent, and loses by an average margin of negative 0.1 percent. The 72 percent success rate of the tilt portfolio implies that there is predictive power in the CAPE – and presumably in other indicators of expected return – that can be used to enhance returns through modest changes to asset allocation over time. The payoff may be even higher in small cap stocks and in emerging markets where market dislocations are more frequent and severe. Even so, the CAPE’s crystal ball is far from perfect. Assuming that the strategy is dutifully executed, one must still be prepared to lose nearly a third of the time.
My takeaway from all of this is that market timing shouldn’t be so casually dismissed by buy-and-hold investors. Market timing may pay off if modestly used and consistently applied, and patient portfolio tilts are made to reflect changes in expected returns over time.
But that is no small "if." How much time do you want to spend -- and how much money are you willing to risk -- to capture the potential payoff?
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.