Over the past several months, there have been many days when financial markets move up or down by 1% or 2%. This level of market volatility often attracts people who try to time the market — to guess when a new high or low is reached, and then to sell or buy stocks accordingly at those points.
Market timing creates a dilemma. While it’s true that markets move in cycles, and there are a number of signals that can help point to these market turns, some investors, magazine writers, and cable TV pundits claim to be able to predict and exploit these inflection points and “beat the market.”
The problem is consistency: It is very difficult for anyone to determine — accurately and consistently — where the stock market and individual stocks are heading. The most successful market timers spend all of their time and attention looking and acting on these market signals. They don’t have “day jobs” like the rest of us.
Even if you think you are able to call the top of the market, and thus know when the best time is to sell, the problem is knowing the best time to get back into the market and start buying. Making both decisions correctly is challenging, even for professional investors. This is because the stock market is made up of millions of investors, each of whom is following their own strategy, on their own timetable. As a result, market movements can be delayed, or present unexpected “noise” during an otherwise good point to buy or sell.
Even more worrisome are investors who chase performance — buying high and selling low. Buying yesterday’s winners (“hot stocks”) and selling yesterday’s losers inevitably hurts tomorrow’s performance. This strategy is counterproductive to sticking to a regular pattern of buying and rebalancing to a target allocation.
Almost nobody has perfect timing. A better, more consistently reliable approach, is known as dollar-cost averaging, whereby you invest the same amount at regular intervals. While this approach doesn’t guarantee a profit or protect against the loss, it has the benefits of helping you avoid procrastination, minimize regret, and avoid the psychologically driven urge to time the market. But dollar cost averaging involves continuous investment in securities regardless of fluctuation in price levels of such securities, so you should consider your ability to continue purchasing through fluctuating price levels. Such a plan does not assure a profit and does not protect against loss in declining markets.
TIME OUT OF THE MARKET CAN BE COSTLY
When markets get volatile, as they have been generally since the start of the pandemic, investors may be tempted to get out. But the presence of volatility doesn’t mean you should sit out. Our firm’s own research shows that the best and worst days to be in the market actually occur in similar environments, all when volatility is above average.
In fact, it can be very costly to liquidate your holdings when you’re under stress. When investments lose ground, they must make up more ground, percentage-wise, just to get back to even. If you lock in a 30% loss, you will need to experience a 42.9% gain to return to where you were before the downturn. Historically, the stock market has always recovered and moved forward, and we need to keep the faith even when the economy looks to be heading for a challenging period ahead. That said, past performance cannot guarantee future results.
ASSET ALLOCATION: A MORE SENSIBLE APPROACH
In general, while every investor is different, you need to think about owning a manageable balance of U.S. and non-U.S. stocks and bonds (or stock and bond funds), in appropriate combinations that are designed to anticipate and respond to changes in the economy, market conditions and individual-security characteristics (or “factors”). Such an approach should not be designed to beat a passive index; it’s to help you achieve a specific goal — such as maintaining purchasing power in retirement or funding a college education. Avoid big moves in your portfolio, which can whipsaw your returns, and instead look for opportunities to adapt your asset allocation strategy or rebalance your portfolio when markets are out of balance. Often your best returns can come during these periods. That said, neither asset allocation nor rebalancing assure a gain or protect against loss. All investing involves risk, including loss of principal.
FINAL THOUGHTS
Academic research and the lived experience of millions of investors have shown that time in the market beats timing the market, especially over long time periods. Making regular investment contributions at steady intervals will outperform making a big investment at the “perfect” time. That being said, you shouldn’t be an entirely passive investor. Markets change, asset classes move in an out of favor, and you need to guard against “portfolio drift.” Consider working with a financial adviser who can help you construct a well-balanced portfolio to support a comprehensive financial plan, and help you manage your emotions when markets get rocky.
This article was originally published in the Pioneer Press.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
Bruce Helmer and Peg Webb are financial advisers at Wealth Enhancement Group and co-hosts of “Your Money” on KLKS 100.1 FM on Sunday mornings. Email Bruce and Peg at yourmoney@wealthenhancement.com. Securities offered through LPL Financial, member FINRA/SIPC. Advisory services offered through Wealth Enhancement Advisory Services, LLC, a registered investment advisor. Wealth Enhancement Group and Wealth Enhancement Advisory Services are separate entities from LPL Financial.
