The Holy Grail
By David Nelson, CFA
The goal of market timing is obvious to all investors. Step out of the market when conditions become unfavorable and quickly buy back when the bottom is in. If you haven’t fallen off your chair laughing yet let me continue. Successful market timing is the Holy Grail and of course incredibly difficult. Obviously, the scenario in the chart below is one of fiction at least from this author.
The reason the average returns of an investor trails the funds they invest in is simply the result of market timing. As markets go down investors sell into the fear and in most cases don’t return until prices are well north of their exit.
According to Morningstar, in the decade ending Dec 31 2013 investors underperformed the average fund’s return by an average of 2.5 percentage points annually. Market timing is a two decision process. Getting the exit right isn’t enough. You have to make a successful entry as well.
I don’t care what your process is but you better have one. If you don’t then stop trading. Ride it out. Truth is, if you were in a balanced account this month you probably fared just fine. Your stocks may have been hammered but bonds kept you in the game.
Some tactical strategies use technical triggers to enter and exit. Others use a combination of macro, fundamental, behavioral or technical triggers to increase or decrease exposure. The key is that it’s unemotional and rules based.
Subjective strategies are tougher to employ successfully. Selling because the market feels heavy or buying blindly into a decline for most will produce inferior returns.
Volatility like we’ve seen this month forces us to take defensive measures. That’s fine, but understand your limitations. Stay within your skill set. I’ve been searching for the Holy Grail 25 years. I suspect I’ll be searching for another 25.