I have written about the perils of trying to time the investment markets for years, but continue to receive questions from readers who use it to manage their TSP accounts, so I thought I’d try again this month. There are a number of ways to effectively attack this misguided strategy and the trick is to find the one that resonates with each investor. This time around, I’ll discuss the risk that market timers either don’t see, or choose to ignore: long-term risk.
Market timing strategies are focused in avoiding near-term risk; the risk of losing money to market declines, or the risk of failing to capture strongest returns when markets rise. Let’s refine our definitions for better clarity. Avoiding the risk of loss through market timing means being out of a market when you should be in it, while avoiding the risk of missing gains means being in the market when you should be out of it. This makes sense if you compare each of these exceptional states to the base, neutral state of being in the market when you need to be to achieve all of your investment objectives. This state is achieved by keeping your account invested in the mix of funds that is reasonably expected to support your lifetime financial goals with the minimum of risk. Timing decisions produce deviations from this base state, which I’ll call “properly invested” from here on.
Of the two timed investment states you can be in; over-invested or under-invested, compared to the state of being properly invested, being over invested is the easiest to discredit. In this case, you’re exposing your assets to the risk of loss to try to capture gains that you’ve already determined you don’t need to support your goals. Why would any rational person risk losing money they’ll need in order to chase gains they won’t? They wouldn’t, and neither should you.
The state of being under-invested is a little trickier to understand. The lure of avoiding the risk of loss is strong and I regularly encounter TSP investors who want to retreat to the G Fund to avoid the risk of losing money in the C, S or I Funds. An otherwise intelligent TSP participant recently recited a common refrain: “The stock market is over-valued, here, and I’ll wait for a better opportunity to get back into stocks.” The basic instinct to avoid risk is beneficial, but a certain amount of risk is probably necessary to achieve your long-term objectives. Failing to take this amount risk, and realize the returns that go with it, will doom you failure down the road, when it’s too late to recover. I think the problem is that few investors can see this risk of long-term failure, and so the short-term risk of loss dominates their view. But, what’s the harm is sitting out of the markets for short periods of time, when the risk of loss seems the greatest, if it makes us feel more comfortable, you ask?
First, your comfort is best on your perception, rather than reality. It’s false comfort. While you might be confident that the market is over-valued, there are thousands of professional investors, with better access to information, better analytic capabilities, more time and more brain power than you who disagree. If they didn’t think the prices of securities fairly represented their value, the prices would quickly fall. You’re basing your decision to be under-invested on nothing more than intuition.
Second, the practical aspects of market timing makes it nearly impossible to succeed in the long-run. If you’re under-invested, you must, by definition, return to being properly invested or be doomed to failure in the long-term. If you’re out of the appropriate markets, you must, at some point, get back in. When will that be? What if your reinvestment trigger is never reached? Is one timing decision all you’ll need, or will you have to make them over and over again? What are the chances that you’ll beat the pros in capturing market-beating returns over and over again? Remember that investing is like a poker game, where you have to take market beating returns from other investors. Everyone can’t beat the market at the same time.
When only the possibilities are considered, market timing might seem like an attractive tool for managing your portfolio, but when the probabilities are taken into account, it’s clearly nothing better than a sucker’s bet – one you’re more likely to lose than to win.
Written By Mike Miles
For the Federal Times
Publication October 6, 2014