Market Timing Does It Work?
“The big money was never made in the buying or the selling. The big money was made in the waiting.” Jesse Livermore
A study released by Fidelity Investments, one of the largest administrators of 401(k) plans, shows that investors who try to time the market lose out. 401(k) participants who pulled out of the stock market from Oct. 1, 2008 to March 31, 2009, but then bought back into the market after that decline, saw an average account balance increase of 25% as of June 30, 2011. This, however, is significantly less than investors who kept their equity allocation relatively steady: These participants saw an average account balance increase of 50% during the same period. “Our analysis reinforces that during extreme market swings, it’s essential for investors not to overreact and remember that investing for retirement requires a long-term view,” writes James M. MacDonald, president of workplace investing for the company.
This Fidelity study is just another addition to a plethora of studies that show that timing the market won’t do you much good. A study by Morningstar, which examines returns over the past decade, concludes that investors who try to time the market end up with significantly smaller retirement savings than buy and hold investors. And another study by Vanguard draws a similar conclusion. The authors write that the average investor “has persistently demonstrated an inability to time the market.”
Bottom line: It may be scary to watch as your stock portfolio plummets. But you’re better off staying calm and sticking to your long-term plan, than you are making rash moves.
Rebalancing means controlling risk, getting better performance and achieving goals
Successful portfolio management is as much about discipline as it is about
making the right tactical decisions. Many investors fail to meet their target because they neither book profits after prices have risen, nor invest after asset prices have fallen. A periodic
rebalancing helps to do exactly this. It is a formidable tool to control risk and realign a portfolio with an investor’s investment goals.
Private investors often neglect an important aspect of portfolio management: disciplined rebalancing can enhance a portfolio’s performance. As markets move higher and lower, a portfolio’s asset allocation will start to drift away from the initial allocation. Rebalancing means bringing the asset allocation back to the targeted allocation and thus bringing it in-line with the desired risk and return characteristics.
Rebalancing disciplines investors to take profit in better-performing assets and buy assets that have recently devalued or have underperformed in the portfolio.
It essentially helps the investor to buy low and sell high.
The Investor Sentiment Wheel shows the correlation of the market cycle and investors’ sentiment.
What's your take on where we're at currently in the cycle?
Because timing is very difficult, you should stay passive invested with your core portfolio at any time for the long-term. Even if you know where we are in the cycle, every cycle seems to be a little different from the last similar in the past. With your remaining satellite portfolio you can try to blend your investments in favour of your cycle guestimate. Do some secenario analysis (including probabilities) to get a better feeling about possible macro (top-down) outcomes and impacts on your asset allocation.
As always, drip feeding money into the market long-term will be a better course for most people than attempting any market timing.
Want a second opinion? Here’s some useful guides from elsewhere (all open in a new window):
“A very low-cost index is going to beat a majority of the amateur-managed money or professionally-managed money.” - Warren Buffett (in 2007)
What emotion is driving the market now?
Are you a rational investor?
Test your investment style.
For long-term investors it is helpful to adopt a framework that offsets the temptation to follow the herd.
The question is: How do we sidestep this behavioral bias of buying high and selling low?
Since year-to-year results for the stock market are very difficult to predict, investors should not be lured by last year’s good results any more than they should be reppelled by poor outcomes. It is better to focus on long-term averages and avoid being too swayed by recent outcomes. Avoiding the dumb money effect boils down to maintaining consistent exposure.
More than 40 years ago, Daniel Kahneman and Amos Tversky suggested an approach to making predictions that can help counterbalance this tendency. In cases where the correlationcoefficient is close to zero, as it is for year-to-year equity market returns, a prediction that relies predominantly on the base rate is likely to outperform predictions derived from other approaches. This suggests that investors should avoid getting too caught up in short-term results and rather focus on an asset allocation strategy that takes a long view.