Time in the market more important than timing
A new client at my financial planning firm asked me this week if the stock market was going to fall, because of the high valuation and global uncertainty.
He was concerned his portfolio would reduce in value and he wanted to take advantage of the possible opportunity to sell high and buy low.
Invariably, the question behind the question is “should I be doing something different with My Portfolio?”.
This is just another version of the market timing question dressed in different clothes.
Should I sell stocks and wait for a more favourable outlook to buy them back? More precisely, can we find clear trading rules that will tell us when to buy or hold stocks, when to sell, when to admit our mistakes, and so on?
The lure of successful trading strategies is seductive. If only we could find them, our portfolios would do so much better.
Motivated by substantial payoff associated with successful timing, researchers over the years have examined a wide range of strategies based on the analysis of earnings, dividends, interest rates, economic growth, investor sentiment, stock price patterns, and so on.
The money management industry is highly competitive, with more stock mutual funds and exchange traded funds available than listed stocks.
If someone could develop a profitable timing strategy, we would expect to see some funds employing it with successful results.
Successful timing requires two correct decisions when to reduce the allocation to stocks and when to increase it again.
Watching a portfolio shrink in value during a market downturn can be discomforting but investors seeking to avoid the pain by temporarily shifting away from their long term strategy may wind up trading one source of anguish for another.
The initial upsurge in prices from their lows often takes many investors by surprise and they find it extraordinarily difficult to buy stocks that were available at sharply lower prices a few weeks earlier.
The opportunity cost can be substantial. Over a 20 year period ending in 2023, the world stock market, measured by the MSCI world index, would have returned an average 10% and the American S&P 500 index would have returned on average 12% per annum, in pound sterling.
But during this period, missing the best 15 days would have shaved the return down to about 6.5%, an alarming reduction.
Add to this likelihood of increased transaction costs and the potential tax consequences of a short term trading strategy, and the odds of adding value through market timing grow even slimmer.
When the news headlines alerts you that everyone is selling, remember that for every seller there is a buyer and the smart investors are the buyers from those who panic and sell.
As a financial planner once said: “a portfolio is like a bar of soap. The more you handle it, the less you have.”
Trust in the capital markets. When you invest, time in the market is more important than timing the market.
