A good time or bad time
The stock market has now been down some seven weeks in a row. The S&P 500 briefly touched a decline of 20% this week. Even bond portfolios are down for the year to date. I propose to write about what this means for the investment decisions we have to make and not make.
Every investor’s situation is different. Some investors may feel they have lost money and that they should be doing something about it. Some may have experienced substantial actual losses and are thinking they should get out of stocks altogether. Some investors will have money to invest and wonder if this is a good time. Some investors, who at some time exited the stock market, may be wondering if it is timely for them the get back in. And no doubt there are some investors who are thinking this may be a good time to fine tune their portfolios or asset allocation. These are the questions I am going to address.
First let me say, it is precious little comfort to be told that real investors are in it for the long haul and that we should not sweat market volatility.
In order to navigate scary market conditions we need more. We need a steady light from a bright lighthouse. We need an investment process that works through thick and thin. And we need to know why it works. So let’s go back to basics about decision making in turbulent markets.
A question of market timing
There is a common theme that runs through these questions of what to do for different investors in a down market. Each of them calls on the investor to make a market timing decision. That is, the investor is wondering if this is a good time to buy or sell. As well, the investor may be wondering if this is a good time to readjust their asset allocation between stocks and bonds.
Let me say categorically that attempts to time the market are one of the greatest sources of underperformance by individual investors and professional money managers alike.
The scourge of market timing affects investors in both individual common stocks and ETFs.
Market timing vs value investing
Let’s look at a comment on this from the fount of investing wisdom, Ben Graham.
Benjamin Graham makes a distinction between ‘the way of timing’ and ‘the way of pricing’. He writes: “Since common stock, even of investment grade, are subject to recurrent and wide fluctuations in their prices, the intelligent investor should be interested in the possibilities of profiting from these pendulum swings. There are two possible ways by which he may try to do this: the way of timing and the way of pricing. By timing we mean the endeavor to anticipate the action of the stock market – to buy or hold when the future course is deemed to be upward, to sell or refrain from buying when the course is downward. By pricing we mean the endeavor to buy stocks when they are quoted below their fair value and to sell them when they rise above such value.” (Graham, The Intelligent Investor, fourth revised edition.1973) p95.
He goes on to say about the investor: “…if he places his emphasis on timing, in the sense of forecasting, he will end up as a speculator and with a speculator’s financial results.” Ben Graham is telling us that “the way of pricing” is the correct path.
Sir John Templeton, one of the greatest investors of the 20th century, wrote in his Maxim 14. “Too many investors focus on “outlook” and “trend.” Therefore, more profit is made by focusing on value.” (Proctor & Phillips, The Templeton Touch, 1983, 2012) p153.
They both making exactly the same point. Don’t make investment decisions based on whether you think this is a good time to buy or sell. Don’t make investment decisions based on your outlook for either the stock market or the economy. Make them based on the investment quality of what you are investing in and whether you are getting really good value for the price you are paying.
A word about ETFs
When it comes to the dangers of market timing, investors in ETFs have it worse than investors in individual common stocks. That’s because ETF investors think they are taking a conservative course.
In a study published in May 2013, Vanguard analyzed the personal performance of investors who switched money between funds or into other funds.
“This analysis compared investor performance in more than 58,000 Vanguard IRAs to two personal rate-of-return benchmarks. For the most part, investors fared reasonably well by choosing low-cost investments and staying the course, even in the midst of a turbulent investment period.
However, a subset of accounts did not fare as well: those who “changed course” and exchanged money between funds. Certainly investors who were simply engaging in rebalancing activities between the same existing funds were not making changes that were detrimental relative to the (automatically rebalanced) benchmarks. However, some of the exchanges were surely reactions to market events, and these investors paid a price for failing to maintain portfolio discipline.” https://personal.vanguard.com/pdf/s801.pdf
The problem with ETFs, compared with investing directly in common stocks of public companies, is that it is virtually impossible to determine whether you are getting really good value for the price you are paying. So ETF investors make their investment decisions based on stories.
A word about tactical asset allocation
Many investment advisors tout their prowess in tactical asset allocation. It sound sophisticated and may be offered as a justification for high advisory fees. Here is how one advisor describes the notion:
“Asset mix – the allocation within portfolios to stocks, bonds and cash – should include both strategic and tactical elements. Strategic asset mix addresses the blend of the major asset classes offering the risk/ return trade-off best suited to an investor’s profile. It can be considered to be the benchmark investment plan that anchors a portfolio through many business and investment cycles, independent of a near-term view of the prospects for the economy and related expectations for capital markets. Tactical asset allocation refers to fine tuning around the strategic setting in an effort to add value by taking advantage of shorter term fluctuations in markets.” (Emphasis added)
I can only say that as far as I am concerned, tactical asset allocation is simply a form of market timing.
We are essentially in a bear market. What to do? Is it a good time to buy or a bad time to buy? Is it a good time to sell or a bad time to sell? The answer is that it is none of those things. Buying or selling may be a sound investment decision depending on the investment quality and value of what you are buying or selling. Buying or selling based on the outlook for the stock market or the economy is market timing and will lead to poor performance.
To dig deeper into the thorny question of market timing, predictions and the investment process see these posts:
To read further on this subject in the Motherlode take a look at these sections in Chapter 26
The broader topic here is asset allocation. To read more about this take a look at my post:
You can reach me by email at firstname.lastname@example.org
I’m also on Twitter @rodneylksmith
You can also use the word search feature on the right hand side of this page to find references in both blog posts and also in the Motherlode.
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