Don’t Let Market-Timing Wreck Your Portfolio
The ebbs and flows in the stock market are often grounded in fear and greed. The latter drives the market into an overvalued state, but fear can erase years of gains in a flash.
We have seen both emotions play out this year. As fears of the impact of COVID-19 took hold in March, the market underwent one of the fastest moves to a bear market that we have ever witnessed. But then the market rebounded with the fastest 50-day rally in history.
Why Market-Timing Is a Bad Idea
Unfortunately, those who attempt to time the market probably got burned by these rapid moves. I read an account from someone just last week on a financial forum I follow:
“Please help. In March my 401k dropped from $110,000 to $87,000. I got scared and moved it into a money market fund. But then I finally decided to move it back when the market was rallying. But today I lost another $7,000 when the market dropped. I don’t know what to do!”
This person made two mistakes that you need to avoid. The first is selling in a panic. You need to always ensure that your risk tolerance is such that you never feel the need to sell in a panic. It’s OK to lighten up on risk, but the time to do that is during a bull market, not after a steep sell-off.
After you sell in a panic and the market rallies, you start to experience the fear of missing out (FOMO). Greed kicks in and you pile back into the market. Then we see another steep drop, as we did last Thursday when the S&P 500 shed 6% (and the person above lost $7,000).
This is a powerful lesson against attempting to time the market. It is a perfect illustration of what is wrong with the concept. You only sell after a loss and you buy back after gains. You experienced the initial declines and missed out on the initial rebound.
Even though the S&P 500 is only down 6% year-to-date, a person who sold during the March decline and bought back well after the recovery was underway likely performed much worse. The person in the example above locked in losses and appears to have lost over 25%, far more than any of the major benchmarks.
A Second Chance
So what is an investor to do?
Don’t try to time market moves. Buy into the market steadily over time and take profits over time. If you need to lighten up on your risk, don’t let greed keep you in too long. Execute your trades and don’t look back.
We could revisit the March lows in the months ahead. There is still a lot of risk in the markets. I think COVID-19 will be a drag on the economy for the rest of this year at least. I am concerned that at some point the stock market will undergo additional corrections due to poor underlying economic fundamentals.
But you need to stick to your plan. If you realized in March that your portfolio is exposed to excessive risk, start reducing that now while the market has recovered somewhat. The market is giving you a second chance to unload risky positions with a much smaller loss, or perhaps even a gain, relative to where you were in early March.
If you rode March out just fine, your portfolio is suited to your risk tolerance and time horizons. We have to accept that there will be occasional steep corrections. But if your portfolio is well-suited to your investment style, you never need to worry about locking in deep losses during a correction. Over the long run, avoiding those big mistakes is a key to building wealth.
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