Topic: How To Invest

Exposing yourself to market timing risk could slash your long-term portfolio returns

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Knowing about the danger of market timing risk will help you protect your gains

We usually have an opinion on the market outlook. But as you know, we downplay predictions, ours included, due to the random nature of stock market prices. Instead, we look for real opportunity and diversification, and we focus on the long term.

All in all, we think you should avoid falling victim to market timing risk, as the timing of downturns is largely random. There’s no dependable way of spotting them before they hit, so you have to rely on guesswork. If you sell and the market rises, it hurts your long-term return and your confidence. If you happen to sell at a good time and you sidestep a downturn, it feels great. But you still need to figure out when to get back in to the market.

In either case, you may wind up getting back in at higher prices than you got when you sold.

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Exposing yourself to market timing risk could cost you thousands of dollars

Stock market timing is the idea that you can determine the right moment to buy a stock or to sell a stock.

However, in the end, the only really successful market timing discipline you can practice is to buy consistently during your working years, and sell your holdings off gradually in retirement. Meanwhile, collect dividends, and buy and sell only in response to clear changes in a stock’s fundamentals. That approach is virtually certain to enhance your investing profits. For one thing, it stops you from selling all your stocks near a market bottom, which market timers do from time to time.

We don’t think you can successfully engage in stock timing. That’s because you can never get away from market risk, and it can cost you money to try. If you only buy when it seems market risk is low, you’ll wind up paying top prices (even though prices may well eventually exceed what you paid.)

Above all, overcome the temptation to think that you can succeed as a fair-weather investor—someone who is in the market when prices are going up and out of the market during the inevitable downturns. If you try to do that, you will wind up selling when much of the damage is done, and buying back in when much of the recovery has already taken place.

Market timing risk: Trying to time the market is sure to cost you money

Many investors start out with an exaggerated idea of the value and importance of market timing. Most eventually become disillusioned with it after they lose enough money.

Market timing can pay off sporadically, of course. Although the results are largely random, successes and failures are apt to come in spurts. The worst thing that can happen to you near the start of an investing career is that you make a series of successful timing decisions. This may lead you to believe that you have a natural talent for market timing, or that you’ve stumbled on a timing process that’s a guaranteed money-maker. Either of these conclusions can spur you to back your future timing decisions with growing amounts of money.

Good timing-based decisions often produce modest profits. They tend to be smaller than the losses you get from bad timing decisions. Needless to say, one of your future decisions is bound to turn out bad. If you’ve invested enough money in it, you could wind up losing much more than your accumulated winnings from prior timing-based decisions.

The worst market timing strategy you can adopt is to yield to hunches or jump to conclusions. I’m sure some skittish investors have been watching the market and trying to spot the next “correction” or temporary market setback. Of course, any market decline could be the start of a market setback.

A significant market setback of, say, 10% or more will come along eventually. Unfortunately, no one can consistently say when that will be. Trying to predict setbacks is sure to cost you money, however. That’s because many of the setbacks you foresee won’t occur. If you act on your prediction and sell, you’ll miss out on profits. You may buy back in at higher prices, just in time to be in the market when the next setback does occur. That’s known as a “double whipsaw.”

Eventually, it happens to a lot of market timers. Some react by giving up on market timing risk. Others just give up on investing.

Rather than trying to time the market, build a sound portfolio using our three-part Successful Investor philosophy:

  1. Hold mostly high-quality, dividend-paying stocks.
  2. Spread your money out across most if not all of the five main economic sectors: Manufacturing & Industry, Resources & Commodities, Consumer, Finance and Utilities.
  3. Downplay or stay out of stocks in the broker/media limelight.

Have you ever attempted to time the market? What were your experiences with it?

How do you defend against a market timing strategy when the overall market is volatile?


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