As any investor from China to America with any exposure to equities learned last year, stock market fluctuations can wipe out half of your nest egg or more in the blink of an eye. While many financial advisors drew the ire of their customers due to reassurances and advice to “stay the course” or “keep a long term perspective”, within a few years, they may be the ones who will have the last laugh.
I can’t tell you how many personal acquaintances and readers of my blogs have commented on how they were completely done with stocks over the past few weeks â€“ they liquidated their investment accounts completely and went into cash, or worse for some of them, into gold. This is the proverbial “market capitulation” which is generally the very bottom when enough investors throw their hands up in desperation and give up, such that the values to be had in the market are too alluring for money on the sideline to ignore. Those who went into cash are now earning 1-2%, which will rapidly lose value to the significant inflationary environment that will come as the economy recovers (as unemployment declines, the Fed will have to raise the Fed Funds target rate to stave off inflationâ€¦and don’t forget, they’ve been printing money like there’s no tomorrow). Those who went into gold may have been hit with a double whammy. Not only did they sell at the bottom of the equities calamity, but now, gold is off its $1000 peak and may yet decline further. In effect, they have picked the absolute worst time to execute both strategies. What is especially painful though is that they just missed a 20% runup in US stocks in 2 weeks by trying to time the market! For every buyer on March 9 (the bottom), there was also a seller. So, you have sellers that lost 50% on the way down from last year’s peak, then, the missed a 20% runup, whereas people with a long term perspective who were dollar-cost-averaging in are looking at a much less painful picture right now.
Rapid Market Recovery
As history has shown, a small number of up days per year accounts for the majority of aggregate market returns in a given year. Even more dramatic though, is the rapid recovery from the market bottom that generally occurs during a recession. Market rallies precede an economic recovery â€“ markets are very efficient in predicting future economic events. Take a look at this candlestick chart over the past 2 weeks. The green bars represent up days and the red represent down days. Some of these up days were in the 4-7% up range.
What Does It All Mean?
In the long run, over spans of 10, 20 years, or more, it has been proven time and time again that retail investors (and about 90% of the time, professional money managers as well) would have performed much better if they had simply left their investments in a diversified portfolio that was formulated to suit their individual risk tolerance and time horizon, rather than trying to time market tops and bottoms. If the best fund managers in the world (and Warren Buffet) can’t time the market, it would be naÃ¯ve to assume that you and I can. Now, trading to exploit near term market inefficiencies and hedging strategies is something different. For investors who employ momentum investing, exploitation of arbitrage opportunities, utilization of stock options for income, etc., there are opportunities to capitalize on the exact phenomena I described above â€“ fear and capitulation. But, I keep my retirement accounts and trading accounts separate and I have a realistic, pragmatic approach to both, with very different strategies. While I’ve been able to turn some good trades in the recent market tumult and opportunities still abound, I haven’t altered my long term approach to my retirement accounts and at the current levels, I’m benefitting from dollar-cost-averaging into a 15-30 year time horizon at depressed prices.
Most of the people reading this article are for the most part, saving for retirement and college in IRAs, 401Ks and 529 plans. Clearly, with a long term perspective, these accounts would be much better off if you “set it and forget it” and only rebalance occasionally if allocations move out of whack over time. But remember, don’t try and time the market in general or you may well sell at the bottom and buy at the top!
About Darwin’s Finance: Financial Evolution tackles both money saving hacks and investing/trading strategies. For more on topics like reader-generated reviews of the best refinance deals out there to alternative investment strategies, subscribe to his feed.