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Market Timing: You’re Doing it Wrong

by Flexo on May 7, 2009

in Investing

A recent question-and-answer article from Money Magazine illustrates the problem with timing the market. While making money in the stock market is as “simple” as buying low and selling high, emotional reactions to the market often prevent that from being a feasible strategy. The question comes from an individual close to retirement, Heidi. She lost several thousand dollars of value in her 401(k) and reacted by selling her equities and keeping the cash in her retirement account.

By the time you lose a good portion of your investment — Heidi doesn’t specify the percentage of loss she experienced — it’s too late. It’s common and expected to sell in a panic, scared to lose more value. A market downturn and quarterly statement after quarterly statement with decreasing bottom lines turn someone who thought they were immune to market swings, a risk taken to increase the chance of higher returns, into a conservative investor. And the reaction comes at the long time.

Invariably, people now scared of the stock market will wait for “positive signs” before diving back into the pool. One such positive sign is a sustained market rebound. But once again, if you wait and react to the positive rebound, you’ve missed the chance to earn the best returns — the kind that drive the statistics that claim the stock market retuns 8% over the very long term. If you are not in the stock market when the market rebounds, and wait until the rest of the world starts buying stocks again, you won’t experience the increase that makes the stock market famous.

With this in mind, it’s better not to try to time the market and react to short-term market conditions. Stay invested, but maintain (and rebalance) an asset allocation that makes sense for your future financial needs. If you need your money to last another three decades, even if you’re starting retiremement and expect to live longer, you may need the boost that the stock market can provide over those 30 years, but it doesn’t hurt to keep a portion of your portfolio — what you will need in the first ten years of retirement, for example — in something less risky.

I’m not a financial adviser, and these thoughts are just based on my observations.

The trouble with market timing, Walter Updegrave, Money Magazine, May 7, 2009.

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What Do I Know About Investing?

by Smithee on January 23, 2009

in Investing

Flexo has often touted the benefits of using a real credit card (as opposed to a debit card) for daily spending, and paying off the balance each month. I guess this finally permeated my skull, since as soon as I saw the news about a credit card that deposits 2% cash back into a brokerage account, I went and got one. At the time, I knew as much about investing as my dog knows about plumbing. I also don’t know a lot about plumbing, but I know how to fill up a water dish, and that’s all the dog cares about.

I did a lot of reading online in preparation, and I’ll be doing a lot more. I even got one of those best-selling books, but I didn’t like what I read in it. That’s okay; it’s just as important to know what you don’t agree with as what you do agree with. There are still plenty of terms I couldn’t define for you, like “solvency”, but my eventual goal is to be a wise, seasoned investor. To start with, I thought I’d summarize for you the things that I’ve read that have resonated with me.

Invest only with the money you don’t need

For the purposes of this article, I’m going to have to assume that you’re not close to retirement. If you are, don’t listen to me. The rules are very different for you; please talk to a financial planner.

I use the phrase “money you don’t need” because I want you to think about the big picture. Think about your monthly budget, savings goals, 3-month emergency buffer, upcoming vacations, birthday and yuletide presents, lofty home improvement goals, and your daydreams of moving somewhere with a nicer climate. Now that you’ve thought about those things, do you have any money leftover? In other words, is it just sort of hanging out in a savings account? If you do, you can consider investing it.

Note: There’s at least one exception to this guideline: company-sponsored 401(k) and IRA plans. If your employer has one of these, and if they’re matching some part of your contribution, take them up on it. My employer is matching 100% of the first 3% of my gross paycheck I contribute, so I’m contributing 3%. This is free money your employer is offering. Now, there’s a good chance that the matching contribution they’re making won’t “vest” (meaning: actually benefit you) until your employment with them reaches some milestone, like 3 or 5 years. So if you don’t like your job, re-think this plan.

Another category of “money you don’t need” is a sudden windfall. You’re chugging along, working within your budget with no credit card debt, and a relative gives you $2,000, or you find through MissingMoney.com that someone owes you $155.

Finally, there’s always the proverbial garage sale. You probably won’t earn enough from a garage sale to make a big investment, I’m just saying it’s free money.

There’s more wisdom on this subject over at fool.com.

There are no low-risk, high-reward investments

Investing and gambling are not quite the same beasts, but they have one huge quality in common: you’ll be making a bet on what you think will happen in the future. And none of us has a plutonium-powered Delorean, flying or otherwise.

Thankfully, brokerage firms don’t offer you free drinks when you’re doing well (on second thought, with some clients they probably do …). My point is that if you’re hoping to see a 50% return on your investment, it won’t be through a mutual fund. So if you want a big reward, you’ll have to forgo a managed investment and make your own predictions, which brings me to research.

You’ll be doing a lot of research

Yes, you’re using the money you don’t need, and you should be willing to lose it, but you don’t want to, so do everything you can to avoid that. Namely, learn about the investment opportunity in front of you. Read about the company, its history, its founders, their histories, etc. We’re living in an Information Age; Google is your best friend.

If you have a friend, even a close one, who comes to you with an “it can’t fail!” opportunity, they’ll probably encourage you to invest all you can, as soon as you can. Take it from a guy who’s just starting to learn (call it beginner’s wisdom): there isn’t a worthwhile investment in the world that couldn’t wait a week for your learned contribution.

If you can, invest as early as possible

I don’t mean quickly, I mean early in your lifetime. I’m 33, so I failed at this. Until now, I’ve had all of my money tied up in food and shelter. I encounter this “start early” advice more frequently than I care to, because it makes me angry at myself. Compound interest is your best friend (Google is now your second-best friend).

But on the other hand, I’ve enjoyed a lot of my life so far, seen a lot of good movies and eaten at some nice restaurants. I wish I’d had the discipline to save even $10 a week when I started working, but I did what I did, and I have to accept that and move forward. If I had that Delorean, I’d go backward, instead.

That’s all I know so far

It’ll be a while before my brokerage account has enough “free money” in it to make any kind of worthwhile investment. In the meantime, I’m going to keep reading, learning from others and absorbing wisdom. I’ll be back every Friday to discuss what I’ve learned and share general investing news with you.

If you have any advice for me or the other readers, please leave a comment or start a topic in the forums (registration password: pluto).

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