Wednesday, July 25, 2012

If Only We Could Time the Market

There is no question that if we could correctly time the stock market, we could make ourselves (and our clients fabulously wealthy).  Unfortunately, this quest is as elusive as Alchemy  and just as much a reality.  A recent post in CNN Money does an excellent job of illustrating just how difficult it is to correctly time the market:

(Money magazine) -- I'm 57 and I've been pretty good at dodging big market downturns over the years. But knowing when to get back into the market is much more difficult. I shifted half of my $700,000 portfolio to cash in May 2011 and then moved the rest to cash in May of this year. I still think the risk-reward balance in investing is totally out of whack, but I'm unsure whether to remain in cash or get back into the market. What's your advice? -- Dennis H., Meridian, Idaho
The major flaw in trying to time the market successfully is that you not only have to make one correct call, but two: exit at the right time and get back in at the right time. What's more, you've got to do it again and again -- as long as you invest -- in the hope of coming out ahead.
The problem is that it's damn tough to get both calls right consistently. To illustrate, let's take a closer look at your two moves to cash.
On the face of it, they worked, kind of. By moving half your stash to cash in May 2011, you avoided a 19% decline in stocks between May and early October of last year. And by shifting the rest of your stash to cash in May of this year, you sidestepped a 9% slide between May and mid-August.
But you didn't gain much. As a result of your moves, I estimate that your portfolio's value today stands at roughly $712,000, a gain of about 1.7% from its $700,000 starting balance. Had you simply stayed in stocks, your portfolio would have been worth almost the same amount, about $711,000, a gain of 1.6%.
So at this point, all your moves have put you ahead by a mere $1,000, or just 0.1%.
You could have done a lot better if you'd been able to combine your claimed agility at sidestepping downturns with an ability to get back into the market at the right time.
For example, if instead of allowing that first $350,000 you shifted out of stocks to languish in ultra-low-yielding cash from May 2011 until today, you had gotten back into stocks just as the market troughed in October 2011, your portfolio would be worth about $795,000 today.