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November 11, 2011

The Perils of Market Timing

It looks promising but rarely works - and failure can be tragic. There is another way.

Economic uncertainty. Volatile markets. Abundant index funds. Ease of trading. Taken together, these elements offer investors the ability to indulge a long-standing tendency – market timing. In an era when crazy financial markets almost feel normal, the past quarter netted a 12-14% decline in major US indices, with weekly swings of 4-7%. This summer, attention bounced between America to Europe and moods shifted from hopeful to dreary to encouraged to dismal. Such a setting may be the new normal for the time being. In the grip of it all, armed with keyboards and touchscreens, what are investors to do? It seems many trade index funds, buying when they sense a bargain and selling when they’re scared.

The 21st Century has given us access to markets and ways to trade them that never existed before, imparting the basic tools to build wealth across the masses. But if people can trade markets more easily than ever, are they successful in practice? The answer appears to be “no.” The latest annual DALBAR study from April 2011 shows investor returns lagged the market itself. Their research illustrates that over a 20-year period, equity investors earned 3.8% compared to the S&P 500 return of 9.1%. Average equity investor retention or holding time was just 3.3 years. It seems people have the tools to invest wisely but are too flighty to stick it out. Add trading costs to buying high and selling low and the result is wealth erosion.

John Bogle can say he told us so. In his book “Don’t Count on It!” the father of the index fund says, “The simple broad market index fund of yore, which I believe is the greatest medium for long-term investing ever designed by the mind of man, has now been engineered for use in short-term speculation.” He says even if you’re right about the market some of the time, you won’t be all of the time, and you’ll get into trouble.

But what good is a static, buy-and-hold approach when you have a lost decade in stocks like the last one? We believe the answer is neither risky market timing nor plodding buy-and-hold. We feel active asset-class management based around economic trends is one of the most effective ways to get consistent outperformance. Since market moves can be deceiving, gauge ongoing portfolio adjustments on established economic data. This can be one of the best ways to avoid market head-fakes.

According to an InvestmentNews interview on 11/10/2009 of NYU Stern School of Business' David Hoffman, “The fund managers who invest based on macroeconomic trends – and are willing to adjust their portfolios as those trends change – are the managers most likely to add value for investors.”



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