Knuff Said Client Edits

Market Timing

Market volatility may be a blessing to some and a curse to others. Recently a friend expressed to me their regret of not having gone to all cash in their IRA two months before the late August pullback (the S&P 500 fell 12% from peak to trough). He asserted that there was "no risk" for him if he had done that. Hindsight is often 20/20 and, yes, if we could all predict the exact moment that markets would rise and fall and aggresively invest or divest our monies accordingly, that would be just splendid. 

It was actually his assertion that "no risk" was involved in the strategy that troubled me. I would argue that a strategy of this nature, going "all in" and "all out" by trying to time market directions actually does involve a very significant level of risk. My response to my friend was, "well how would you know when to get back in?" To which, he said: "when the market has dropped enough". I replied: "Interesting. Well, how much is enough? And, how do we know exactly when we've reached that point and ensure we don't miss out on the recovery?" This, of course, was a question that he could not answer.  

The fact is that, as the nearby chart (Chart A below) attests, if an investor in the S&P 500 index missed just 40 of the best days between January 3, 1995 and December 31, 2014, their return went from an annualized 9.85% return down to a -0.45% return. That would equate to an investor growing their $10,000, invested in 1995, to $65,453 versus an investor who missed just 40 days out of those 20 years having only $9,140!

In fact, when looking at 20 year annualized returns between 1995 and 2014 (Chart B below), the S&P 500 returned an average of 9.85% per year, a 60/40 equity/bond portfolio returned an average of 8.7%, while the average investor returned ONLY 2.5%! Why the large underperformance? The answer: poor market timing decisions. Simply put, investing decisions based on emotions, fear, exuberance, or greed can lead to poor results. Investors tend to buy high and sell low.

Now that we've observed some of the potential risks of trying one's luck with market timing, let's look at a few more reliable strategies.  

Change the Game:

1. Have a plan: Your target asset allocation.

 Your overall asset allocation will, over time, potentially provide the biggest impact on your overall investment performance. Start off with a simple target allocation of Cash, Bonds, and Stock that fits your needs, risk tolerance, and goals.  Don't over-extend yourself with equities. 

Your target allocation should be set so that it allows you to be opportunistic and view market corrections as buying opportunities. Keep enough cash to cover living expenses and enough of a safety cushion to get you through unexpected expenses, but also keep a certain amount around that you would view as investable money for when those buying opportunities present themselves.

2. Review and Rebalance.

Use your asset allocation to take some of the emotion off the table.

"Recency" is a psychological term that refers to how people have the tendency to believe that what has happened recently will continue to be in the future. This is why investors often end up buying high and selling low. When markets are screaming hot and going up daily, investors pile in buying more and more at higher prices; and at market bottoms, in the depth of despair, investors often decide to run for the exits and sell at lows thinking that there is no floor in sight!

Instead, if you use your target asset allocation as a guide, it will allow you to escape the alluring pitfalls of "group-think" and you can be more opportunistic with your money. 

For example, if your target allocation is 50% equity, and the market goes up 20%, your equity allocation will now be 60%. In this case you might consider reducing your equity allocation by 10% (sell high!). Conversely, if the market falls 20% you will only have 40% in equities so you should consider adding 10% (buy low!). 

You can follow a similar discipline within your equity allocation when looking at specific sectors (e.g. technology, energy, health care, etc.) and asset classes (e.g. international, emerging markets and small cap stocks, etc.). You may want to adhere to a target asset allocation for those subsets as well. 

Obviously, it is prudent to take the macroeconomic environment and any sector or company specific factors into consideration. It is quite common for sectors or individual stocks to become over-valued in times of excess or under-valued in times of pessimism. Target allocations can and should be flexible depending on your financial situation and macroeconomic factors. Take advantage of these situations in a similar fashion as you adjust your asset allocation back towards your target.

Let's Talk.

Investing is an ongoing process, as well as, a bit of a learning experience. We are all wired a bit differently. Even when we are managing your money for you, it helps for us to hear your questions and know your concerns. As your wealth changes, your family grows and your career develops, your perceptions and priorities will likely change as well.  Enjoy the journey!

Keep in touch.

Chart A-  J.P. Morgan Guide to Retirement 2015 EditionSM (click to enlarge)








Chart B-  J.P. Morgan U.S. 3Q 2015 Guide to the Markets® (click to enlarge)






*Asset allocation cannot eliminate the risk of fluctuating prices and uncertain returns.

*Stocks offer long-term growth potential, but may fluctuate more and provide less current income than other investments. An investment in the stock market should be made with an understanding of the risks associated with common stocks, including market fluctuations.  

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