I am regularly approached by Thrift Savings Plan investors with stories like this: “I made a big mistake
with my TSP account. A few years ago, I lost a ton of money when the markets crashed, so I took all of my money out of the C, S and I Funds and put it into the G Fund. I’ve missed most of the rising stock market since then and I’m worried that I can’t afford to sit on the sidelines forever. Maybe I should just bite the bullet and get back into the market before it’s too late.”

To the investors who tell this story, the challenge is to improve their market timing skills. To me, the
problem is much bigger, and much easier to solve.

What these investors are really saying is that they have demonstrated a lack of ability to predict the future and now they’d like to try to do it again and see if they can do better. They’re assuming that they have a chance of improving this skill of seeing the future. And they’re willing to risk their life savings to try to do it.

Learning how to manage a portfolio by trial and error with real money and little or no formal education is a poor bet. More bluntly: It’s a terrible bet that’s far more likely to fail than to succeed. There’s too much at stake, and the learning curve is too steep. Like any complex skill — and prudent portfolio management is one of the most complex you’ll find — it takes lots of experience to master. Even one lifetime of experience is not likely to be enough. How many bear markets can you afford to go through to test your theories and develop your skill? For many, one botched market cycle is enough to do severe and irreversible damage to your lifetime standard of living.

This is why market timing is such a risky and reckless investment management strategy. Its goal is to
beat the market. To beat the market, you must be able to see or know something that the market can’t. No one has this ability — at least, not in a way that is reliable and useful.

These facts mean that, rather than skill, timing is based on luck. Each time you try it, you’re going to
either succeed or fail.

If you fail, the damage has been done and, if you’re smart, you’ll learn from your mistake and avoid
making the same mistake (market timing) again.

If you succeed, you’ll give yourself credit and try it again. This is another big mistake investors often make — confusing luck with skill, which can lead to a downward spiral.

In the 1990s, many investors assumed that skill was behind the tremendous performance of their stock portfolios. In a rising market, more risk usually equals more profit, so confused investors tend to pile on more risk. Then, when their portfolios are at their riskiest, and most vulnerable to loss, the market crashes and they lose much or all of what they made on the way up. Shell-shocked from the losses, they exit the market after the crash and miss much or all of the recovery. Eventually, the lure of the rising market becomes irresistible and they reluctantly buy back into the market just before it is ready for the next crash.

This cycle is based on human psychology and is at least as common today as it has ever been. In other words, as a group, investors don’t learn very well or very quickly.

I’m well aware of the negative aspects of asset allocation as an investment strategy. It’s not perfect. If you are always invested in stock.

Written by Mike Miles
For the Federal Times
Publication June 10, 2013