Timing is Everything—Except
in Investing
Seek success through
diversification
It is a tantalizing prospect, one that lures
investors with the siren song of easy profits: the
temptation to "time the market"—to buy
when stock prices hit bottom and sell when they are at
their peak.
If only it were that easy.
Adam Reed, a finance professor at the University of
North Carolina at Chapel Hill, understands the
challenges that can trip up would-be market timers.
"To be successful," he explains, "an
investor would have to consistently get into the
market just before it booms and just before it busts.
In effect, the market timer would have to know
something that nobody else knows.
"It's hard to imagine how an individual
investor, with limited time to follow the market and
fewer resources than professional money managers have
at their disposal, could consistently buy and sell at
the right time."
Nonetheless, Reed acknowledges that everyone wants
to get the highest return possible on his or her
investments. And when unusual bouts of volatility
(such as those we've experienced of late) send the
market rocketing or plummeting almost daily, some
investors try to exploit the momentum.
Guessing Wrong Can Be Costly
"One problem with market timing is that it is
driven not by facts, but by emotion—specifically,
fear and greed," says Frank Boucher, a certified
financial planner in Reston, Va. "This can cause
market timers to make poor judgments."
Indeed, as many market timers discover, their
approach leaves little room for error; even small
mistakes can have a significant impact on performance.
For example, because stock market rallies often occur
in quick bursts, missing just a handful of
"up" days can seriously compromise returns.
Consider the table to the right. Over the 21-year
period through 2008, the S&P 500®
Index produced an annualized return of 8 percent. But
by missing just the 10 best trading days during those
two decades, an investor would have lost 3.4 percent
per year in returns. And missing the 40 best days (or
fewer than 1 percent of the total number of trading
days) would have dragged a portfolio's annual return
down into negative territory, well below the period's
rate of inflation.
Don't Time—Diversify Instead
In light of the available data and his own
experience, Boucher strongly discourages clients from
trying to time the market. "Particularly over the
last year, I've had clients say to me, 'I'll get out
of the market now and get back in later when stocks
are ready to come back.' I ask them how they'll
recognize the right moment and explain to them that if
market timing could be done reliably, everyone would
do it.
"I believe that, for individual investors, the
key to long-term investment success isn't to time the
market, but to diversify your portfolio by using a
comprehensive asset allocation strategy—and then
sticking with it."
Boucher recommends the following approach:
- Assess your specific needs. Your personal
situation is unique; no two investors have exactly
the same goals, time horizon and tolerance for
risk. Construct a portfolio that supports your
objectives.
- Plan to manage short-term volatility.
Diversification has been described as not
"putting all your eggs in one basket."
Because different types of securities, such as
stocks and bonds, don't always move in lockstep
with one another, chances are that some of your
holdings are doing well at any given time.
- Use asset allocation to diversify.
Through asset allocation, investments are spread
among stocks, bonds and cash instruments—even
among different types of investments within each
asset class. A properly diversified portfolio will
own large-, mid- and small-capitalization stocks;
international and domestic equities; treasury,
corporate and municipal bonds; and cash-equivalent
securities, such as money markets and certificates
of deposit.
Finally, rather than trying to make a quick killing
by jumping in and out of stocks, follow your long-term
strategy through all market conditions, Boucher
recommends. Over the past 82 years—through wars,
recessions and political instability—stocks have
been up more than twice as often as they have been
down.*
In the long run, diversification—not market
timing—is likely to reward patient investors.
