Market Timing
Market timing is easy to understand. One famous advise is ‘Buy Low’ and ‘Sell High’. Can I invest in stock market now? The implication of market timing is you need to wait. Wait for what? Perfect timing. Timing to achieve what. Wait till stock prices are going to be low and buy. When should one sell? Wait when the price is high to sell and profit. So the expectation is to buy very low and sell very high and profit. Market Timing thus panders to investor sentiment to earn profits by somehow finding the lows and highs and make multiple trades and profits. Is it achievable and realistic?. We will see in following presentation.
Why Market Timing is Hard
Market Timing is difficult in reality. The main reason is the stock that is bought does not behave neatly going from a low price to high price. The stock moves in at least five different ways
1) Stock does not go up but stays flat going a bit up and down. This reduces the investor interest in the stock and ability to hold to the investment.
2) Stock rises up a bit tempting one to sell but not reaching target profit. Stock price traces back to starting price and goes down. The investor is confused by these movements and experience reduces his confidence on timing the market.
3) Stock goes down initially and creating some anxious moments and then comes back up a bit. In this scenario the investor is made to wonder if they need to exit the stock as it has gone down initially.
4) Stock price goes down steeply for a certain period of time due to some macro economic event (say Covid) for a few months. This is the worst case scenario for the investor. This scenario tests the investor patience. Investor ability to hold the stock is highly compromised and likely to sell her positions. That is she has bought high and sold low opposite of general advise.
5) Stock goes linearly up. This is the investor’s ideal scenario. This is only case where things go as plan. However this also does not does not give investor much learning. The other scenarios outlined also happen. Investor is not prepared to face them when they occur. This linear scenario just builds a false sense of confidence.
So when pundits urge to time the market it mainly fits to one scenario above. But all of scenarios can happen in random order and timing is extremely hard to get right. Most investors will find market price movements are overwhelming.
One of the key reasons why market timing is hard is that it requires a high level of accuracy in predicting market movements. Even if predictions are correct some of the time, a few incorrect predictions could significantly impact your overall returns. In addition, markets can be highly unpredictable and can be influenced by a wide range of factors, making it difficult to accurately forecast future price movements.
Time in Market
There is an alternate approach to Market Timing. When should you buy? Now. There is no need to wait for a perfect time. Invest in a broadly diversified portfolio based on your asset allocation now. Hold the investments for a longer period 7-10 years. This approach does not focus on timing but time in market to generate returns.
Diversified stock investments or passive index funds grow over time. The growth reflects underlying economic growth. Although it is difficult to predict their movements over a short time frame – over long time frames they generate consistent inflation beating returns.
Identifying when the performance happens, market timing, is difficult. However staying invested in long term generates a consistent performance. Long term orientation avoids the temptation and panic cycle based on market price movements. This approach allows for short term fluctuations of market and money is allowed to grow over long term.
All long term wealth builders have a long investment horizon. Hence they benefit from growth due to time in market than market timing. So it is typically better to adopt a long-term, diversified approach that takes into account your financial goals, risk tolerance, and other factors.
What is Long Term
Time in market is good but what is the time we are taking about for getting inflation beating returns.
Buy and Hold means equity investments are to be held forever until you need for some expenses. So in a way one Buys ( Low or High ) and holds on for as long as one can and then take things out on a need basis. This is a ideal time-frame of Long Term.
What does one do for short term needs? As we need to support our expenses over short time frame – equity investments are not ideal for this. Short-term debt investments in government bonds or corporate bonds as a cover for emergency and short term expenses.
Long Term expenses can be allocated to Equity and they can grow over relatively longer periods of time generating consistent returns. So what kind of minimum time frame one needs to look at for holding equity. For this one needs to go with historic returns in India and elsewhere. Equity Mutual Funds have historically delivered 3-4 % Real Returns. If inflation is 6%, they have delivered 9%-10% if held over 7-10 years’ time frame.
Equity investments are essentially volatile in nature in short term. One needs to holds them for time periods as above to benefit. Unless this long term orientation is built – one will get sucked into market movements. This leads to sell at a low price and exit without benefiting from the bounce back over period of time.
In summary – Equity investments have delivered superior real returns, when they are to be held for long periods.
The long term or time in market is roughly 7-10 years and ideally much longer. Historically Equity mutual funds have delivered 3-4% real returns above inflation. And the longer the time frame higher the odds of success and lesser the risk.
Retirement Challenge
What is the strategy one has to adopt in Retirement?
In Retirement there is money needed for immediate expenses. As one ages there is risk aversion and one does not want to see ones money erode in value. However there is need to invest some part of retirement in equity investments to earn real returns above inflation. And the time duration of when this equity investments will be accessed can be made based on long term performance duration of 7-10 years. Short term bonds and corporate bonds need to cover short term expenses. Equity portion covers a portion of retirement expenses and time be allowed for recovery from any short term fluctuations.
Considering time in market needed for equity – an asset allocation between bond and equity needs to be designed in line with needs and risk appetite of retirees.
Summary
- Market Timing is appealing but difficult to pull off as predicting market movements accurately is very difficult.
- Time in market or buying and holding for a long term has generated consistent return for Equity investments.
- Diversified holding of equity and debt held over a long term in line with ones risk tolerance and financial goals is best approach to get super rich over long term
