Market Timing – Our Thoughts
December 9, 2021
A number of clients have recently inquired about taking money out of the stock market because they fear a severe downturn in stocks. Most U.S. stock indices are up significantly this year. This is after strong returns for stocks, especially growth stocks over the last three years. The pandemic has caused economic uncertainty and many investors see a disconnect between rising stock prices and this uncertain environment.
There can be good reasons to reduce an investor’s allocation to stocks and the best time to do it is when the market is strong. Many investors receive regular distributions from their portfolios and PSG makes these distributions from investors’ bond accounts, since they are relatively stable. When the allocation to bonds falls below our target, reducing stock holdings to replenish the bond account is necessary and appropriate. For other investors who do not receive distributions, we also target a specific percentage allocation to stocks because of their risk tolerance. For these clients, rebalancing to reflect the agreed upon risk level is also appropriate.
On the other hand, if an investor wants to reduce their overall stock holdings because of fear, it is often a mistake. The big issue is timing. The first question is when do you sell? The second question is when do you repurchase stocks with those funds? You have to get both sides of the trade right to make it work. Some will say when stocks decline x% we will go back in. So, someone who sold in March 2020 or in the past year is still waiting to reinvest. The S&P 500 has gained over 115% from March 23, 2020 to November 19, 2021. The other issue is taxes. While investment decisions should not be driven totally by taxes, selling stocks with gains can be costly. The stocks would need to be repurchased at a much lower price to break even after taxes.
Timing the market accurately on a consistent basis is almost impossible. Many people get it right once or twice but missing it a few times can permanently damage returns. Making a broad market call is different than selling an “individual” stock. Our firm was started in 1991 and we witnessed firsthand the challenges of correctly timing the market right away. In 1991 the S&P 500 gained over 31%, but the vast majority of that return was earned during a few weeks in January and December. If you were out of stocks the wrong 2-3 weeks that year, you missed a large majority of the rally.
An important study of market timing was completed by Bank of America this year and recently referred to in The New York Times, titled “For Stocks Time Really Is Money.” It found that from 1930 through March 8, 2021, the S&P returned 17,715% cumulatively. Nearly all of those gains occurred in a small number of random days. If one excludes just the 10 best days for each decade, nearly all the gains were erased. Without those days, the S&P 500 had a return of only 28% over more than 90 years.
No one can predict when the big days will occur. This is why we resist market timing for its own sake. We care deeply about our clients’ emotions concerning risk, and we understand how difficult it may be to “sit tight” when the market is in a severe decline if the news is bad. The way we address this is with a comprehensive financial plan and an asset allocation that is appropriate for each client’s risk tolerance, not by trying to time the market.
December 8, 2021