Sports commentators often predict the big winners at the start of a season, only to see their forecasts fade away as their chosen teams lose. Similarly, market timers often try to predict big wins in the investment markets, only to be disappointed by the reality of unexpected turns in performance. For those who do not wish to subject their money to such a potentially risky strategy, time and not timing could be the best alternative.
What Is Market Timing?
Market timing is a strategy in which the investor tries to identify the best times to be in the market and when to get out. Relying heavily on forecasts and market analysis, market timing is often utilized by brokers, some investment advisors and market punters to attempt to reap the greatest rewards for their own or clients’ money.
Proponents of market timing say that successfully forecasting the ebbs and flows of the market can result in higher returns than other strategies. Their specific tactics for pursuing success can range from what some have termed "pure timers" to "active strategic allocation."
Pure timing requires the investor to determine when to move 100% in or 100% out of one of the three asset classes — stocks, bonds, and money markets. Perhaps the riskiest of market timing strategies, pure timing also calls for nearly 100% accurate forecasting, something nobody can claim.
On the other hand, dynamic asset allocators shift their portfolio’s weights or redistribute their assets among the various classes, based on expected market movements and the probability of return versus risk on each asset class. Professional mutual fund managers who manage asset allocation funds often use this strategy in attempting to meet their funds’ objectives.
Risks of Timing the Market
Although professionals may be able to use market timing to reap rewards, one of the biggest risks of this "strategy" is potentially missing the market’s best-performing cycles. For example, suppose an investor, believing the market will go down, removes his investment monies and places them in more conservative investments. While the money is out of stocks, the market instead can enjoy its best-performing month. The investor has, therefore, incorrectly timed the market and "missed" those top months. That is why perhaps the best move for most individual investors, especially those striving toward long-term goals might be to purchase shares and hold on to them throughout market cycles. This is commonly known as a "buy-and-hold" strategy.
The Potential Risk of Missing Out (Source : Standard & Poor’s Journal of Financial Planning, 2006)
A B C
1976-2005 1986-2005 1996-2005
[1] Untouched $36,479 $9,547 $2,384
[2] Miss 10 Top-Performing Months $ 12,742 $ 3,880 $1,109
[3] Miss 20 Top-Performing Months $5,855 $1,931 $619
Perhaps the most significant risk of market timing is missing out on the market's best-performing cycles. Columns A, B, and C represent the growth of a $1,000 investment beginning in 1976, 1986, and 1996, and ending 31 Dec 2005.
Row 1 shows the investment if left untouched for the entire period shown above; Row 2 shows the investment if it was pulled out during the 10 top-performing months; and Row 3 shows the investment if it was pulled out during the 20 top-performing months.
As seen in the above table, purchasing investments and then withstanding the market’s ups and downs can often work to your advantage. Though past performance cannot guarantee future results, missing the top 20 months in the 30-year period ending December 31, 2005, could have cost you $30,624 in potential earnings on a $1,000 investment in Standard & Poor’s Composite Index of 500 Stocks (S&P 500). Also consider a $1,000 investment made in 1996 that was left untouched until 2005, it could have grown to $2,384. But missing only the top 20 months in that 120-month span could have cut your accumulated wealth to $619.
Though many debate the success of market timing versus a buy-and-hold strategy, forecasting the market undoubtedly requires the kind of expertise that portfolio managers use on a daily basis. Individual investors might best leave market timing to the experts and focus instead on their personal financial goals.
Compounding: Time Can Work for You
If you’re not a professional money manager, your best bet is probably to buy and hold. Through a buy-and-hold strategy, you take advantage of the power of compounding, or the potential for your invested money to make money. Even Albert Einstein took notice of compounding. When asked what was the most important thing he learned from mathematics, he replied, "Compound interest. It’s the most powerful force on earth." The compounding power of investments can also help manage risk over time.
Reevaluate Your Portfolio Regularly
Buy and hold, however, doesn’t mean ignoring your investments. Remember to give your portfolio regular checkups, as your investment needs will change over time. Most experts say annual reviews are enough to help ensure that the investments you select will keep you on track toward meeting your goals.
For example, a young investor will probably begin investing for longer-term goals such as marriage, buying a house, and even retirement. The majority of his or her portfolio may be in stocks and stock funds, as history shows they have offered the best potential for growth over time, even though they have also experienced the widest short-term fluctuations. As our young investor ages and gets closer to each goal, he or she will want to revisit the portfolio to rebalance assets as his or her financial needs warrant.
This hypothetical investor knows that how much time is available plays an important role when determining asset choice. Most experts agree that generally, a portfolio made up primarily of the "riskier" stock funds (e.g., growth, small-cap) may be best for those saving for goals more than five years away. On the other side, investors nearing retirement, or saving for shorter-term goals, or those who see a possible need for cash in the near future, might consider a portfolio weighted toward money market instruments. Remember, though, that because people are often living 20 years or more beyond their last official paycheck, even those enjoying retirement should consider the potential inflation-beating benefits as well – hence, there are still valid reasons for them to consider investing into stocks and stock mutual funds, although they may need more regular portfolio check-ups than the younger investors.
Time Can Be on Your Side
Clearly, time can be a better ally than timing. The best approach to your portfolio is to arm yourself with all the necessary information, and then take your questions to a financial professional to help with the final decision making. Above all, remember that your investment decisions, both long- and short-term should be based on your financial needs and your ability to accept the risks that go along with each investment. Your financial professional can help you determine which investments are right for you.
Points to Remember
1. Historically, although past performance is not indicative of future results, a buy-and-hold strategy has resulted in higher gains over the long run.
2. A big risk of market timing is missing out on the best-performing market cycles.
3. Missing even a few key months can substantially affect portfolio earnings.
4. Market timing "strategies" which range from putting 100% of your assets in or out of one asset class to allocation among a variety of assets are based on market performance expectations.
5. Market timing is best left to professional investment managers.
6. Though buy-and-hold is a smart strategy, regular portfolio checkups are necessary.
7. Time horizon is particularly important when determining asset choices.
8. Riskier investments can be more appropriate for longer-term goals.
9. As goals get closer, portfolios should be rebalanced.
10. Even in retirement, portfolios should contain investments for earnings to seek to keep pace with inflation.
1 comment:
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