Market timing is
enjoying great appeal today. Yet the case against this investing
technique grows stronger literally with every passing day. Recent data
taken from the Center for Research in Security Prices (CRSP) shows this
vividly. The chart below shows the utter futility of trying to guess
what will happen in the markets.
This striking graphic
shows how missing only a few of the market’s best days would have a huge
negative effect on the returns of an investment in the S&P 500 during
this recent 10 year period. The most dramatic message contained in the
chart is the fact that out of over 3600 days, if you had missed the best
40 (a little over 1%) of the days, you would have lost 5.6% a
year vs. gaining 9.2% if you had stayed in. That is a 14.8%
difference! Please keep in mind this time period represents some of the
best and worst years in market history. So given this evidence,
why would any prudent investor sit on the sidelines and wave at those
still marching in the market parade? I would suggest that the reason
lies in two of the classic investing mistakes that investors have made
since investing began. The first is panic - pure and
simple. They see the storm around them (pending war, economic slump,
etc.) and take their eyes off of the goal and the facts that tell them
that staying the course is the only sensible way to proceed. The
talking head investment analysts all say something different depending
on hemlines, Super Bowl results or what bubble they think will burst
next. The general media is contributing to the volatile atmosphere by
reporting mostly bad news because good news does not sell advertising.
So what do investors think other than the sky is truly falling? But
just like the age-old fable, it never did, or will.
The other classic
mistake involves running for cover in cash and fixed income
instruments and out of equities while the stock indexes are down
dramatically, as they are now. Investors often see bonds as a
traditionally “safe” investment vehicle that will calm their nerves and
enable them to miss the bad stock market. Besides missing the
inevitable stock upturn, I would suggest that given the current interest
rate environment, the next big market downturn will be in the bond
market and not the stock market. If this holds true then safety will be
only an illusion and not a reality. Unfortunately, this fact will be
learned too late for most.
So
what to do? The alternative to market timing is long term steadfast
investing. Adhering to an Investment Policy Statement regardless
of short-term fluctuations eliminates any guesswork. (If you do not
have an IPS – get one!) Giving way to fear will undermine your
investment program every time. There may be times and circumstances
when an adjustment in your asset allocation is needed. But make sure
this decision stems from the long-term strategy as outlined in your plan
and not from overconfidence that you can predict market movements.
Whenever you become tense about markets, review the historical data to
regain your confidence in your long term strategy and remember this
simple thought – it is not timing the markets, it is time in
the markets that brings long term investment success.
(5/03)
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