11/12/2013 4:45 PM ET|
You really can time the stock market
Yes, most people who try to time the market screw it up, but that doesn't mean the idea is flawed. A few key statistics can help average investors buy low and sell high.
The idea of trying to "time" the market -- of trying to get in before it goes up, and get out before it goes down -- has a terrible reputation.
Timing "is a wicked idea -- don't try it, ever," wrote Charles Ellis, one of the leading lights of index investing, many years ago.
According to conventional wisdom, any attempt to time the market is fundamentally flawed. Stock markets follow a "random walk," they say. No one can predict the market's next move, so trying to do so will end up costing you money. A lot of your long-term gains will come from a few big "up" days, and these are completely unpredictable -- if you are out of the market when they happen you will miss out on a lot of profits.
Money managers often push this idea to the clients. It has, from their point of view, a side benefit: It helps keeps the clients fully invested at all times, which means their assets are generating more fees.
But is the idea correct? The simple answer: No.
Yes, most people who try to time the market end up screwing it up -- they buy and sell at the wrong times -- but that does not mean the idea is flawed. On the contrary, historically, "smart" timing, based on market fundamentals, has been one of the soundest ways to beat the market and produce above-average investment returns over the long term.
What is smart timing? Simple: It is long-term timing, and it is based on following a few solid valuation metrics.
It is not about trying to trade short-term. It is not about selling stocks on Wednesday and planning to buy them back on the following Monday. It is not about obscure market technicals like "head and shoulders" formations or Bollinger bands.
It is about cutting your exposure to stocks when the market is expensive in relation to fundamentals, and keeping your exposure down -- if need be, for years -- until the market becomes much cheaper. It then involves increasing your exposure, and keeping it high, again for years if necessary.
The myth of 'random' returns
Techniques available to anyone have worked, and worked well, for more than a century. That does not mean they will work in the future, but it is a strong argument in their favor.
First, let's demolish the myth that the stock market produces entirely "random" returns -- that some years it's up, other years it's down, that over time it just goes up, and no one can predict anything in advance.
According to long-term data tracked by New York University's Stern School of Business, an index of the top 500 U.S. stocks has produced since the late 1920s an average return of about 9.3 percent a year, when you include reinvested dividends.
That sounds like a great return, and it's the sort of thing money managers often tell their clients. But it contains two hidden nasties.
The first is that it isn't adjusted for inflation, which means that in real spending-power terms you made several percentage points less each year. And the second thing is that those returns did not come randomly. They came in long waves -- bull markets followed by bear markets followed by new bull markets. They were not random at all.
Using Stern's data and inflation numbers from the U.S. Labor Department, I stripped out the hidden inflation in the stock market returns and looked at the "real" returns -- in other words, the returns in actual purchasing power. This is what actually matters. Then I looked at these returns over ten-year periods. The reason for that is that if you are an ordinary investor -- rather than a trader on Wall Street — what you are usually looking for is somewhere to grow your money soundly over the medium to long term.
You can see the results in this chart -- and these results are not random. They are nothing like random. The waves are as clear as -- well, as clear as a big wave at Sunset Beach.
If you invested in the stock market in the 1940s or early 1950s, you earned spectacular returns as you cashed in from the gigantic postwar boom. And if you invested from the late 1970s to the early 1990s, once again you earned spectacular returns in the subsequent returns due to the huge boom from 1982 through 1999. Lucky you.
But what about at the other times?
Hmmm. If you were unlucky, or foolish, enough to invest in the late 1920s, the later 1930s, or between 1963 and 1973, you were right out of luck. Your returns were terrible. In many cases you actually lost money on the stock market, after accounting for inflation.
Not just for one or two years. More than 10 years.
So even though since the late 1920s the average ten-year "real" return to U.S. stocks (after inflation) has been about 6.4 percent a year, a quarter of the time it was actually less than 1.3 percent -- a number I chose because it happens to be the guaranteed "real" return on long-term inflation-protected U.S. bonds (I own a few) available right now. When you deduct taxes and investment costs -- even in low-cost funds -- the actual returns earned by most investors were lower still.
Remember how people tell you the indexes will never let you down if you stick with them for five to 10 years? It's nonsense.
Note also, please, that these 10-year figures do not include any allowance whatsoever for volatility. Someone who invested in Wall Street in 1928 and held on for 10 years earned a real return of just 0.25 percent a year, after accounting for inflation. But just to earn that miserable payoff he had to stick with his stocks during the biggest crash in modern history, the 90 percent collapse of 1929 to 1932.
If he lost his job, or even just lost some of his nerve (understandable), and trimmed his position in the meltdown, he didn't even get his 0.25 percent a year. He probably lost money.
The go-with-the-flow crowd pretends that these long periods of poor performance are basically costless. "Just sit there and wait," they say, "and the next bull market will come along in due course. Don't try to time these things." But that's deeply disingenuous. While you are earning nothing in stocks, you are missing out on gains in bonds or other assets.
The full cost of waiting out these bear markets is horrendous. When you factor in the fees, the taxes, the volatility and the opportunity cost of what you could have been earning elsewhere, the investor gets hosed.
More from MarketWatch:
VIDEO ON MSN MONEY
"You really can time the stock market"
You're absolutely right. I definitely can and have done it. Let me show you. Loan me all your money at 0% and I'll invest it and split the profits with you. We can't lose, I get stock tips from Jim Cramer.
I personally will not ever listen to a broker as I did back in 2008 time frame. They all preach the same BS; diversify (even in bad bond markets such as now) and ride out the so called ups and downs. Don't do this!!
No, I bail out of a market if I think things are not going to get better in the short term. Short term to me is within a year. As for holding of bonds at this time again, no way. I do have stocks and a few mutual's but they are all top S&P products.
I also, sell off my stocks anytime I make profits within various ranges that I pre determine depending on the markets the stocks are in. It could be as low as 4% or as high as a 12% or more increase. I may or may not buy back-in on down sides. My point is I do not hold and wait, I time a market the best I can and have made more money this past three years than when I listened to a broker / crook.
Yes, but they were NOT clear until AFTER they occurred.
I read and reread this entire article to see if I missed something: the method of predicting when an upward or downward slope of a wave will BEGIN to occur. It's not there.
He says, "Remember how people tell you the indexes will never let you down if you stick with them for five to 10 years? It's nonsense."
I don't remember anyone ever telling me that. You can go to any long-term S&P 500 or DJIA chart and see it isn't true.
What I DO remember, is people telling me that if you buy Blue Chip, dividend-paying stocks with long records of near-constant growth in revenues, earnings, and dividends without incurring a lot of Long Term Debt, you have very little chance of losing money in a 10-year period.
It's also true you can't time the market - especially if you use this article to tell you how.
Timing=luck, or maybe insider info.
Of course everybody likes to buy low and sell high, but when they do, that doesn't mean they are onto some secret. If they were, do you think they would be talking about it? No, they'd be lighting their cigars with $100 bills on their private jet, laughing all the way to the Cayman Islands Bank.
I know several people who cashed out right at the bottom, back in early 2008 when the dow was below 7k. Now that's timing. No, just plain stupidity.
I think the writer is spot on. I remember the tech boom and equated it to tulipmania. I have been this worried about the market since then. I'm up 39% over the last 12 months was 100% invested until August when I trimmed it back to 80% and I trimmed it back again this week to 30%. The market is only being supported by Fed. When the fed starts to ease the market will drop, or more accurately when people THINK the fed will ease the market will drop.
Very recently net-short; Doug Kass spoke on Bloomberg this A.M. he is as well. Good company...
Best of Luck to All.
Also if market timing is so easy why is the track record for active management not much better than random guessing?
So can you really Time for the longer TERM. I say a person can if they have enough INFO. However, with so many factors and manipulators involved, that's almost impossible. How can you have INFO on all the important players. Can you Rely on past returns to be reliable indicators of future returns. Heck no. Every ten year period will be up or down relative to what's affecting it. That will never be exactly the same. No two people are even likely to have the same Cost Average and or Buy date so even quoting 10 years returns is pointless.
No real value here. This is manipulating the statistics to fit your agrgument.
In this case, limiting the term to 10 years. Increase it to 15 years and you'll see investing and holding for 15 years has always been worthwhile.
Copyright © 2014 Microsoft. All rights reserved.
Fundamental company data and historical chart data provided by Morningstar Inc. Real-time index quotes and delayed quotes supplied by Morningstar Inc. Quotes delayed by up to 15 minutes, except where indicated otherwise. Fund summary, fund performance and dividend data provided by Morningstar Inc. Analyst recommendations provided by Zacks Investment Research. StockScouter data provided by Verus Analytics. IPO data provided by Hoover's Inc. Index membership data provided by Morningstar Inc.
More Market News
|There’s a problem getting this information right now. Please try again later.|
MUST-SEE ON MSN
- Video: Easy DIY smoked meats at home
A charcuterie master shares his process for cold-smoking meat at home.
- Jetpacks about to go mainstream
- Weird things covered by home insurance
- Bing: 70 percent of adults report 'digital eye strain'