Market timing is an impractical way to invest
Investors are experiencing FUD (fear, uncertainty and doubt) and asking about getting “out of the market.”
I’ve been investing for 40 years and I’ve never been comfortable. That’s why Mark Twain said, “October is one of the particularly dangerous months to invest in stocks, the others are July, January, September, April, November, May, March, June, December, August and February.”
“Getting out of stocks” is market timing. Many studies have looked at the value of trying to time the stock market. The conclusions of these studies have all been similar. Market timing doesn’t work because stocks move randomly up and down too quickly to accurately time. Over a 10-year period (3,650 days from Jan. 1995 to Dec. 2014) missing just 10 of the best days cut 10-year average annualized returns from 10 percent to 6 percent. This is the reason Warren Buffet said, “The stock market is a device for transferring money from the impatient to the patient.”
Rather than getting in and out of stocks, you need to carefully decide how much money you are comfortable with allocating to the stock market despite the ups and downs. In making this decision, you need to understand that market volatility has been unusually low the last 10 years. Historically, it is normal for stocks to correct by 10 percent, on average twice a year, and a 20 percent correction can be expected every four or five years. Corrections of greater than 20 percent typically correlate with recessions, which you might expect every 10 years. We’ve had 10 recessions in the U.S. since 1950.
Therefore, you need to understand the possible depth and frequency of stock market corrections and that timing the stock market is impractical. You need to consider if the expected market corrections would trouble you so much that they might cause you to get out of the market altogether. That is, would fear of further drops cause you to sell your stocks when the market is down? You need to be confident that whatever amount you allocate to stocks, you will be able to hold without selling until the stock market recovers. This is also why you need to have a long-term outlook. You don’t want to be in the middle of a correction or recession and find it is necessary to sell stocks while the market is down. It’s important to be in a position that stock investments don’t need to be sold until the market recovers.
In the current market environment, where stocks have been going up for many years, you need to be watching your portfolio carefully. When stocks go up, you may need to rebalance your portfolio back to the target allocation. For example, if your intended allocation is 50 percent stocks and 50 percent bonds, but you find your portfolio allocation is currently 60 percent stocks and 40 percent bonds, then rebalancing it by selling 10 percent of your stocks and reinvesting them in bonds would be a logical and prudent thing to do. Over the long-term this strategy allows you to achieve the average expected return you need to accomplish your investment objectives.