Stop trying to time the market and do this instead

SmartAsset: You can't time the market.  Here's what to do instead during times of market volatility

SmartAsset: You can’t time the market. Here’s what to do instead during times of market volatility

The war in Ukraine, ongoing Covid concerns, market volatility and the threat of a recession are enough to make even seasoned investors worry – especially about how much of their portfolio is in stocks. Amidst all the stress, including about current and future events, the stability of fixed income securities or even cash can start to look more attractive than stocks. Consider working with a financial advisor as you build a long-term investment plan and asset allocation.

What is market timing?

Market timing, which is the opposite of a buy-and-hold strategy, is buying or selling because you expect a specific change in the price of a stock or the value of an index. If you think the stock is going to go up, you might be planning to sell. If you think the stock is going to go down, you might as well sell right away. In contrast, if you think the stock will fall, you can schedule a buy order, while if you expect it to rise, you can buy immediately. It is a form of active management.

In all cases, market timing is based on price volatility. While issues such as asset fundamentals and financial planning may play a role in decision-making, they are simply elements of a decision that revolves around expected price changes. The purpose of market timing is to turn these predictions into profit. By planning your buys and sells, you can – or hope you can – move before the market does and collect the profits.

The terrible experience of market timing

Numerous studies by disinterested parties demonstrate the failures of market timing. To download just a few examples:

  • Merrill Lynch survey found that model portfolios over a 30-year period could underperform by almost half their value through market timing.

  • Charles Schwab tell us that their “research shows that the cost of waiting for the perfect time to invest outweighs the benefit of even the perfect time. And since timing the market perfectly is about as likely as winning the lottery, the best strategy for most of us mere mortal investors is to not try to time the market at all.”

  • A research of Putnam Investments found that market timers who miss just 10 days in the market can lose up to half the value of their portfolio. Their model found that an error of no more than a month was the difference between a $6,873 return and $30,711.

Why market timing usually fails

There are several reasons why market timing usually fails. One reason is that very few can consistently predict short-term market movements. This applies to spotting a downturn before it starts, as well as knowing when the market will recover. Deciding to reduce exposure to stocks, moving those assets into money market investments or cash, means not only anticipating when to exit the market, but also choosing when to re-enter the market, write Judith Ward and Roger Young of T. Rowe Price in a recent article. In other words, it requires two actions at a successful market moment.

Check out the illustration from T. Rowe Price below.

SmartAsset: You can't time the market.  Here's what to do instead during times of market volatility

SmartAsset: You can’t time the market. Here’s what to do instead during times of market volatility

This chart follows two hypothetical investors who each deposit $2,000 per month into their investment accounts. One investor maintained a stable asset allocation while the other, who let anxiety affect investment decisions, jumped in and out of 3-month Treasuries as cash equivalents every time stocks fell 10% or more for a quarter. Obviously, over time, the “stable” investor does significantly better than the “anxious” investor.

Another reason why the market schedule imposes such a high cost on investors is that over time, stocks provide more reliable capital appreciation than bonds. So dumping them because they’ve lost value, or because you expect them to lose value, eliminates the possibility of profiting from that capital gain.

Alternatives to market timing

What to do instead of trying to time the market depends on what your main concerns are.

  • If your main concern is having enough money to live on, then it makes sense to accumulate enough savings to cover two years. This is especially true for those who are about to retire or have already retired.

  • If your main concern is to get protection against a big decline in the stock market, then maintaining or moderately increasing your bond allocation makes sense.

  • If your main concern is to miss the market recovery, consider investing little by little, gradually buying stocks. You don’t have to spot it perfectly. Research from T. Rowe Price’s investment team shows that rebalancing stocks during a downturn historically improves performance the following year, even if that correction is made several months before or after an official market bottom.

Bottom row

SmartAsset: You can't time the market.  Here's what to do instead during times of market volatility

SmartAsset: You can’t time the market. Here’s what to do instead during times of market volatility

It can be tempting to fantasize about how you’re just one perfectly timed pair of trades away from a seven-figure net worth. The catch is that “perfectly timed” part. The fact is, in times of market volatility, it’s impossible to know when it might end. Investors who believe a change in strategy is appropriate may consider incremental adjustments. They could also wait until volatility subsides to make major changes to their strategy. What you shouldn’t do is succumb to the siren song of market timing. You could spend thousands on hot tip newsletters or subscriptions to financial websites, each promising sure-fire advice on market timing. However, the only people who make money from these tips are the people who sell them.

Investment advice

  • Health care threats, foreign wars, and a looming recession may tempt you to change your asset allocation suddenly and dramatically. But there is a great risk in this. A financial advisor can help you approach investment decisions rationally rather than emotionally. Finding a qualified financial advisor doesn’t have to be difficult. SmartAsset’s free tool connects you with up to three financial advisors who serve your area, and you can interview your advisor matches for free to decide who is the best fit for you. If you’re ready to find an advisor who can help you achieve your financial goals, start now.

  • Determine how your money will grow over time with this free investment calculator by SmartAsset.

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Photo: ©iStock.com/Altayb, ©T. RowePrice, ©iStock.com/JuSun

The message Just face it, you can’t fix the market: do it instead during market volatility first appeared on SmartAsset Blog.

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