Has the recent stock market tumble got you spooked? According to media reports, problems with the subprime lending markets have provoked a “surprising collapse” in stock prices since late July. Despite some days of rising stock prices since then, we are led to believe that the downward spiral will surely resume and that as an investor, something must be done to prevent catastrophe.

Why am I writing about this? Why do I care? Only because I have, once again, had to field phone calls and e-mails from concerned Thrift Savings Plan investors questioning the wisdom of remaining invested in stocks during such a perilous time.

Even though my livelihood and my family’s financial security directly depends on my ability to successfully manage the investment portfolios of others, I rarely pay attention to the daily, weekly or even monthly fluctuations in stock and bond market prices. Only when my phone starts to ring and questions in near-panic tones start to flow, do I have to stop what I’m doing and look at a stock chart.

I look only to provide some visual evidence of what is invariably the reality of the situation: Investment timing is a fool’s game, particularly when the fool is near or in retirement and needs the invested money to support a desired or necessary income.

I don’t mean to be insulting in characterizing market this way. Market timing is a fool’s game in the same way that playing the lottery is a fool’s game — the odds are against you and you’re unlikely to come out ahead and make a profit. I buy lottery tickets from time to time, the same way I buy theater tickets — with a trivial amount of money and for entertainment purposes only. Buying a lottery ticket with your life savings, or even a significant chunk of it, and risking your standard of living in retirement is a different thing entirely.

Take a look at a few facts lead me to this characterization:

  • Stock prices, particularly in the short run, are unpredictable. Notice that I didn’t say “difficult to predict.” They are not predictable, period. That’s because short-term moves in stock prices aren’t driven by fundamental economics but by the behavior of crowds — buyers and sellers — many of whom are paid and are free to spend millions of dollars trying to outthink each other. The subprime lending market rationale is a perfect example of this crowd behavior. Investors knew well before July 20 — the day the stock markets began their recent decline — that liberal lending practices would lead to trouble, but they continued to bid stock prices higher. The Standard & Poor’s 500 index was up more than 12 percent over the preceding four months and nearly 20 percent over the preceding 12 months. The market moves in fits and starts because of psychology rather than economics.
  • You’re not that smart. Don’t ever forget that stock trading is a zero-sum game — a feeding frenzy of sharks over profit. For one investor to win, another must lose. This happens all the time, but no one investor is smart enough to win consistently. Do you really think you’re any match for Wall Street’s best-educated, highest-paid and most determined stock traders? You’re not. Sure, you can get lucky timing your trades to market upturns and downturns, but the odds are that with such a strategy Wall Street will take your money over the long run. Even professional stock traders tend to just pass the trading profits around among themselves, with their take-home pay coming from investors’ fees. The odds say that it’s more profitable to get paid to trade stocks
    than to actually trade them.
  • When it comes to retirement, market timing or trading is counterproductive. For younger investors, those with many years until the time they will begin drawing from their TSP accounts to provide income, there is a fairly wide margin for error in investment decision-making. Since you are not taking regular withdrawals from your account, time can heal many wounds caused by unusually bad market performance. As you approach and enter the withdrawal period, the margin for error shrinks dramatically. Rather than focusing on potential return, as you had in the past, your attention needs to move to risk. Poor investment performance, when coincident with cash withdrawals, can be devastating to a retirement plan.

Retirement investing is a game of predictability. Getting the return you expect each year in retirement is much more important than the potential for larger-than-expected returns.

As a retirement planner, I’m happiest when the return delivered by an investment strategy is at or near the expected value. It’s unpredictability that hurts retirement plans. When you attempt to trade in and out of markets, you actually increase the risk in your portfolio, decreasing the predictability of returns and inhibiting its ability to support a future stream of income.

Adding your timing decisions to an investment in any of the TSP funds actually adds risk without adding any expected return — not what a prudent investor sets out to do.

Look at the performance of the S&P 500 as of Aug. 29: up nearly 350 percent over the past 20 years, up more than 57 percent over the past five years, in spite of the 7 percent decline since reaching its all-time high in July.

Maybe you think that, since the TSP doesn’t have any obvious trading costs, you can avoid the big declines in value and ride the upswings — selling high and buying low — to beat the markets. You might get lucky. But you run the serious risk that your decisions will be wrong, will actually reduce returns or add to the volatility of those returns, and you’ll have to reduce your withdrawal expectations to help insulate you from this added risk.

The sad irony is that in attempting to intervene and reduce your exposure to risk in investing, you’re more likely to add risk to the equation.

The risk that markets will fall is inherent in investing, and factored into the returns you receive. You must take this risk to obtain that return. On the other hand, the risk that your unnecessary investment timing decisions will be wrong is not factored into the returns you receive. You take that risk for free.

Written by Mike Miles
For the Federal Times
Publication September 3, 2007