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(b)Market Timing: The Two Most Dangerous Words in InvestingTwo hikers are on their way up a mountain trail when a large bear spots them and charges. One hiker immediately drops to the ground, pulls her running shoes out of the backpack, and begins taking off her hiking boots.
"Are you crazy?" her companion shouts. "You can't outrun a bear!"
She looks up at him and says, "I don't have to outrun the bear. I just have to outrun you."
You can't outrun a bear market either. It's tempting to think you can, by timing your entry and exit in an unstable market, but the overwhelming evidence is that market timing doesn't work consistently, and leaving may be more harmful than doing nothing.
There are two forms of market timing: intentional and unintentional. Both are deadly to your portfolio.
(c)Intentional Market Timing
It seems so simple. Buy when stock prices are low and sell when they are high. Thousands of investors are unable to resist the temptation: All they need do is look back at the stock that went from $10 per share to $50 per share to see how easy this is.
Unfortunately, 20/20 hindsight doesn't help you look forward. It doesn't help you identify the stock that went from $10 to $50 any more than it warns you about the stock that went from $50 to $10.
Market timing has its proponents. You don't have to look very far or hard to find folks who will gladly call the market turns for you if you subscribe to their service. Some of these market timers are very sincere about their approach and believe they can provide a real service.
Others, however, are just short of frauds. One of their tools is trotting out "historical" data that shows how their system called the market correctly for the past 10 years, or whatever. They base many of their systems on back testing, which takes a trading system and applies it against historical market data. Done objectively, there is nothing wrong with this approach. However, if you manipulate the system to produce the best results based on the historical data, you have crossed the line between testing and moved into the realm of shell games: You can't duplicate their results because they tweaked the system to work with a market that won't exist again.
Caution Save your money and don't invest in expensive newsletters that offer to predict market turns. There is no credible evidence that they work.
The sincere proponents of market timing don't promise triple-digit returns every year. Instead, they hope to improve your odds by suggesting possible market turns based on fundamental and technical analysis.
Most market timers appear to be do-it-yourselfers. A striking example of this band of hardy souls is the day trader. You remember day traders don't you? In the waning years of the 1990s, they were the hottest act on Wall Street. You couldn't open an investing publication or cruise the Internet without reading about a former cab driver making $50,000 a week day trading at his kitchen table in his underwear. When the dot.coms became dot.bombs, the day traders disappeared from the media. The untold story, even during their peak, was that very few day traders were making money even when the market was red-hot.
Another form of market timing that ran rampant during this pe-riod was the IPO craze. Just about any new Internet or tech company that went public experienced huge run-ups of its stock almost overnight. This was the origin of the dot.com billionaires who became so famous. Most of their wealth was in the stock and stock options they held. Investors tried to cash in on the huge gains, and some managed to do so by buying early and getting out quickly with a reasonable profit, but the market wasn't very kind to those who got in late and didn't get out quickly. The super-high prices for most of these stocks didn't hold, and people lost much of their investment.
Caution The IPO craze drove people to pay incredible prices for young companies with no track record. In fact, many of the companies had no profits and no working products. For example, I am aware of a company that went public around $20 per share. Within a short period, the stock was selling for over $100 per share. It didn't stay there long and fell to $14 per share. All of this happened in less than 12 months. (As I write this, the stock is trading for $23 per share less than two years after it went public.)
The sad truth is that many of the hot IPOs were trading at or below their offering price within six months to one year. After the Nasdaq meltdown that began in the spring of 2000, many of these former high-flyers have disappeared altogether.
(d)The Unintentional Market Timer
The unintentional market timer is the investor who jumps into the market without much of a plan and has no idea what to do when things turn sour. People are very emotional about their money-especially when they're losing it. They jump in impulsively and bail out without much more consideration.
The late-1990s bull market made making money look so easy, and attracted many investors with little or no experience in the market. Investors and potential investors watched the Internet/tech stocks go crazy along with the Nasdaq index. Typically, they waited until the market was way up before investing; then, deciding the bull market was going to be around for a while, they charged into the market. With no real knowledge of market dynamics, they bought overpriced stocks that ultimately proved to have only one way to go with any momentum-and that was down. When the market turned and their stocks began to fall, they watch helplessly as their money evaporated. Some cut their losses quickly or even took a small profit. Others froze like deer in the headlights. Perhaps they convinced themselves that a "buy and hold" strategy would see them through. When prices didn't bounce back, they sold in frustration and left the market in disgust. But not just the novices suffered. A number of seasoned professionals also took big hits because they put aside their disciplined approach to investing and ran with the excitement.
Caution The heady days of the Internet/tech bull market were full of optimism and a sense that anyone could make a fortune in the market. Unfortunately, when the bubble broke, many watched the market fall, sure it would bounce back any minute. Markets do fall, and they can fall much farther than you think.
(c)The Truth About Market Timing
The truth is that market timing, intentional or otherwise, doesn't work. No one can consistently call market turns and neither can you. (I can't either.) Here are some simple truths about market timing:
- [lb] No one knows what the market will do tomorrow, next week, or next year.
[lb] Unless index funds make up your portfolio, there is no guarantee that your investments will turn with the market.
[lb] In most cases, you are probably better off invested than not: Buy and hold.
[lb] Timing the market takes a lot of time.
[lb] Timing the market often builds huge tax bills.
No matter how many numbers you crunch, there is no way to figure out what the market is going to do next with any degree of accuracy. For all the numbers and analysis, stock prices are still reflections of expectations. If investors expect a company to be more profitable in six months, today's price reflects that expectation. But a lot can happen in six months. Active investors (those who trade often) even have another layer of expectations: What stock will everyone else want in six months? Add in unanticipated factors outside the market, and you can see why knowing the market's next move is so complicated.
Tip It is hard not to be impressed with some of the Internet pundits writing and making predictions about the market, but if you check the site archives, you may find that their track record is not so great.
Anyone who tells you what the market is going to do next month is guessing. When you guess, sometimes you are right, and sometimes you are wrong.
(d)Your Investments May Not Follow the Market
Although the majority of stocks will follow a bear market to lower prices, it is not true of every stock or even every stock sector. Historically, utilities and dividend-rich stocks have done better in slowing markets than other sectors. Food and consumer staples tend to hold up well in bear markets. (People still need to eat and brush their teeth.)
You can't be sure that your investments are going to drop at the same rate as the market. Some (such as technology stocks) may drop considerably faster and farther than other sectors.
Plain EnglishIndex funds are mutual funds that attempt to mimic a particular market index. An index fund based on the S&P 500 buys representative shares of the index, so the fund rises and falls with the index.
Some advisors suggest that you put your money in a good stock index fund and forget about it. An S&P 500 index fund is going to rise and fall with the market. If you have a long time horizon before you need your money, this is an easy way to ride out down markets. That is not always the best strategy, however, especially if you're approaching a financial goal such as retirement.
You're Better Off InvestedThere is significant evidence that staying invested in common stocks or stock funds is a good defense against a bear market. Investors who suffered through the super bear market in 1973 and 1974 were sorely tested. It must have been difficult to watch the market bleed out almost 50 percent of its value.
The investment community has a lot of respect for the "buy-and-hold" strategy. Unfortunately, investors don't always listen to the full strategy; they assume that if they buy a stock they should hold it forever. Simply put, if you buy a piece of junk today, it will still be a piece of junk in 10 years. "Buy and hold" assumes you acquire quality investments and they remain quality investments during the holding period.
In Chapters 7 and 8, we will discuss when it is time to sell a stock or a mutual fund. As I said earlier, bad things happen to good stocks. When they do, you need a plan and methodology for deciding when to sell.
The buy-and-hold strategy also assumes you have a long-time horizon before you need these investments for a financial goal. As we saw in Chapter 1, it can take years to recover from a bear market. If you are looking at retirement in a few years, you cannot afford to wait through a lengthy bear market and lengthy recovery.
Unfortunately, your options are more limited if a bear catches you unprepared. In Chapters 8 and 9, we discuss preparing your portfolio for retirement by moving assets into more secure investments.
What can you do? First, don't panic. Now is the time for some very careful decisions. Too many investors react in an emotional manner and take themselves out of the market. You cannot afford to abandon the market completely. Remember, you may have 20-plus years of retirement to support. The market has historically returned close to 12 percent, and you will need some significant returns to make your remaining assets stretch.
Don't make the gambler's mistake of "doubling up to catch up." In other words, high-risk investments may have gotten you into this mess, but they won't get you out. Consider moving into lower-risk products like bonds, real estate investment trusts, and income-producing (dividend) stocks.
The hardest decision of all may be to go back to work or not retire immediately. Delaying retirement or going back to work will give you much-needed cash and give your investments a chance to recover. The longer you delay withdrawals from your investments, the longer they will earn a return for you.
You will do yourself a big favor by contacting an investment professional to review your situation before making any big steps. The right course of action depends on the assets you're holding and many other factors unique to each investor. Make this move quickly to minimize the damage.
(d)Timing the Market Takes Time
If you feel you just have to try market timing, be prepared to spend most of your time staring at your computer screen. You need patience and practice to find the perfect moment to trade. Ask any day trader how much time they spend watching for those moments. In the end, you will still be wrong more times than you are right. A number of software packages and online services will help you spot trading times. Most of the tools used by market timers involve technical analysis: studying price movement and volume numbers of individual stocks. The goal is to find a moment when a stock's high is not going to hold or when the stock has hit bottom and is on the way up. Technical analysts plot the numbers on charts and analyze them for patterns. A number of Internet sites construct and update charts on selected stocks.
Tip Technical analysis is an important tool in deciding when to buy and sell an investment; however, you should use it in connection with a fundamental analysis of the investment for maximum effectiveness.
I believe technical analysis can provide valuable information to investors, but it's not a science with foolproof results. Purists trade stocks of companies they know nothing about other than that the charts look good. This seems to violate one of the important rules of investing: Know what you are buying.
(d)You Have to Pay the Tax Man
I have an agreement with my tax-attorney friends that I repeat in all my books: I don't practice tax law, and they don't sue me. So far, it's working out pretty well.
Active investors, folks that trade frequently, are almost by definition market timers. They are looking for an opportunity to jump in, take a profit, and retreat. They may not trade as often as day traders, but they trade much more frequently than the average investor. These frequent trades can create a hefty tax bill.
Investments held less than one year are subject to tax just like regular income. You will need to pay any federal, state, or local taxes; Social Security and Medicare taxes; and any other applicable tax. Factor in brokers' fees and any services you pay for, and it becomes clear you need to be very good at market timing to keep your head above water.
(c)Avoiding Snap Decisions
As I noted earlier in this chapter, the unintentional market timer is prone to making snap decisions on when to enter the market and when to exit. These decisions are usually wrong, and if they aren't wrong, you just got lucky.
There is no substitute for doing your homework before you buy a stock or mutual fund. There are numerous books (including Alpha Teach Yourself Investing in 24 Hours, Alpha Books, 2000) that will give you the tools and information you need for successful investing.
Caution Investing can involve a considerable amount of emotion. Try to keep your decisions based on information, not hunches.
Equally important but often overlooked is a notion of how and under what circumstances you will sell the investment. We will cover that topic in detail in the next two chapters. The bottom line is that you should have a reason for buying an investment-overhearing a conversation in the elevator doesn't count. Equally important, you should have a plan for selling the stock if necessary.
(c)Value Timing in a Bear Market
I hope you have concluded by now that I am not a fan of market timing. Almost no one with expertise in investing believes it works. However, bear markets do offer an opportunity to take advantage of bargains. We will discuss bargain shopping in detail in Chapter 15, "Fatten Up on Bear."
Down markets are very tempting times to pick up bargains-at least, so the conventional wisdom goes. What I call "value timing" is the notion that you can grab some real bargains at the bottom of the market and take a nice profit on the recovery.
Here's the problem: You can't be sure where the bottom of the market is. As the Nasdaq began dropping off its high of 5,000-plus, when would you have called the bottom of its drop?
- At 4,000, a 20 percent drop?
- At 3,000, a 40 percent drop?
- At 2,500, a 50 percent drop?
You see, the problem with fishing off the bottom is that you can never be sure where the bottom is. Few, if any, investors believed in 1999 the Nasdaq would fall this far or this fast.
Tip Buying or selling an investment on price alone is often too narrow a criterion for long-term successful investing.
The hard lesson is: Don't invest on price alone. If the investment doesn't make sense based on its fundamentals or, most importantly, on how it fits into your plan, don't risk your money.
(c)Always Another Deal One of the other dangers of market hysteria, whether it's a bull or a bear market, is the sense that you have a "once-in-a-lifetime opportunity." If you don't act now, you will never have another chance.
The recently deceased bull market of the late 1990s may be one of the strongest in history, but it won't be the last one. There are plenty of opportunities for profitable investing every day the market is open. Some days you just have to work harder than others.
The point is that you should never jump into or out of an investment because you feel that failing to act will cost you the opportunity of a lifetime.
Don't believe it. There is always another deal.
Market timing doesn't work. Research shows you are better off invested in the market than jumping in and out in an attempt to improve your return.
Always buy and sell within an overall investing plan. You will do better and will avoid impulsive buying and selling...
Table of Contents1. Bear Market.
2. Investing as a Contact Sport. Risk and Reward. Types of Risk. Market Risk. Economic Risk. Inflation Risk. Conclusion.
3. Types of Bear Markets.
4. Economic Indicators.
5. Market Indicators.
II. BEAR TRAPS.
6. Market Timing: The Two Most Dangerous Words in Investing.
7. When It's Time to Sell a Stock.
8. When It's Time to Sell a Mutual Fund.
III. BEAR ASSETS.
Asset Allocation: The Two Most Important Words in Investing.
10. Asset Allocation in a Recession Bear Market.
11. Asset Allocation in Inflation and Deflation Bear Markets.
12. Bear-Proof Assets.
IV. BEAR TRACKING.
13. Age-Appropriate Strategies.
14. Short-Term and Mid-Term Strategies.
15. Fatten Up on Bear.
V. BEAR DEN.
16. Pre-Retirement Strategies.
17. Retirement Protection.
18. Safe Havens.
VI. BEARSKIN RUG.
19. Your Best Bear Strategies.
20. Diversify or Die.
21. Your Weapon of Choice.