When I first started in investing one of the cardinal rules (for the general public) was “don’t try to time the market”. From a practical perspective this meant that you were supposed to continue putting money in the market whether it went up or down and then hold for the long term.
Everyone knew that the market does move in cycles, such as the giant bust at the time of the great depression in the 20’s and the 30’s when stocks crashed, wiping out many investors. Another classic example is the Japanese stock market which peaked in 1989 at around 39,000 before falling to a low of 7000 in 2009, over 80% below its high (today it is around 10,000). Even the most cursory review of the chart shows that if you sold at the peak and / or bought at the trough (this hasn’t worked yet in Japan because the market hasn’t moved back up yet) you’d make a tremendous amount of money; but the popular wisdom is that it was “too hard” for an individual investor to determine when to enter and exit the market so don’t try at all.
To some extent “re-balancing” is a form of market timing, because as stocks rise in value if you practice the model you are supposed to sell off some stocks and buy bonds (or whatever else is in your portfolio, could be commodities or real estate) which accomplishes much of what market timing is supposed to do. Re-balancing is more complex because it involves multiple asset classes which each have their own valuations but you could say that re-balancing is at least a “cousin” of market timing.
While everyone’s situation is different this graph shows Portfolio One, the longest of the portfolios that I run at “Trust Funds for Kids” for my nieces and nephews. This graph neatly shows the immense power of market timing during the critical period 2007-2010.
In order to understand this graph, you need to know that we invest $1500 / year in each portfolio (I put in $500, the beneficiary puts in $500, and I match $500) so this is a classic “dollar cost averaging” model where we put in money at fixed intervals regardless of the markets’ performance.
In 2007, the market was mostly flat, and we made an investment of $1500 late in Q3 2007, right when the market took a punishing drop. As you can see the value of this incremental investment was immediately devoured by a drop across all the stocks in the portfolio. From a high of $14,000 when the investment was made in Q3 2007 (the scale on the right is in dollars) the portfolio skidded to a sickening drop of around $9500 in a matter of months, or a loss of over 30% by early 2008.
Since that nadir in 2008 at $9500 we have invested $3000 more in the portfolio ($1500 in Q3 2009 and $1500 in Q3 2010) so the “base” value ignoring any gains in the interim would be $9500 + $3000 = $12,500. And now the portfolio is worth over $20,000! Thus the portfolio gained $20,000 – $12,500 in value or $7500, a gain of 60% (calculated by dividing the gain of $7500 vs. the base of $12,500).
One thing that has been constant during this time is my “strategy”, which consists of picking from a list of (mostly) large capitalization stocks that is split roughly 2/3 US and 1/3 international in this portfolio. Thus swings weren’t caused by a change in strategy or an improvement in my stock-picking capabilities (a topic of much amusement for Dan) – these changes were solely caused by a move in the aggregate market.
Thus what can I conclude based upon this experience – that market timing is pretty much everything. ANY STOCK you bought in 2007-8 appeared to be a tremendous LOSER when the market fell out in late 2008-9, and ANY STOCK you bought at the nadir in 2009 is a WINNER today. I am obviously exaggerating a bit here because some stocks rose or fell based on their own particular circumstance (think BP) but this rule cuts across the vast majority (90%+) of the total stocks in the market, especially if you have a relatively diversified portfolio like Portfolio One.
I’m not telling anyone anything that isn’t obvious to many people, especially professional investors or technical analysts. There still is a large population of the general public, however, that are starting to wake up to this (they know their stocks got killed all at once and then rose) but in general they don’t know what to do with these hard-won insights.
For the portfolios I run for my nieces and nephews I am not going to a market timing method although I do try to sell off stocks I viewed as over-valued or stocks I think aren’t going anywhere. Since I re-invest the proceeds into other stocks, however, the portfolios are still just as exposed to the overall market. There are a lot of reasons for this but the main one is consistency, this model has generally worked and it is understandable to them (you work over the summer and we make regular investments) and these funds are supposed to be a help not their entire source of income and support.
If you did want to “time the market” there are a vast number of tools and indicators that you can use. Pick up any trading or professional investment journal and there are myriad software applications and methodologies to choose from starting with the classic price / earnings ratio on to super complex methods that are way over my head. I am not advocating any of this do your own research and your own planning but the performance of this portfolio neatly shows the impact of the overall market and how it generally dwarfs the impact of individual stock selections.
Cross posted at Chicago Boyz