The Impossible Task: Guessing Right Twice!
Billy Joel once sang, “These are the times to remember as they will not last forever.” I’m pretty sure he wasn’t referring to the equity markets, but it’s certainly relevant today. I often hear the question: “Does it make sense to pull back equity exposure in preparation for a ‘correction’?”
Survey says: “No!”
We’d be foolish in believing the markets won’t pull back or have corrections. In viewing market levels today, we see elevated valuations (nine years since the credit crisis ended). The question isn’t whether corrections will occur. Rather, it’s can we time getting out at the top and back in at the bottom? The task at hand isn’t guessing right once; its guessing right TWICE! History has shown it isn’t just difficult, but almost impossible.
What do I mean?
There are two ways to keep money during a market downturn. You can either sit tight and do nothing (until the markets rebound), or you can try to get out at a higher level than when you reinvest. While the first option sounds easier (and it is), the reality is many investors choose to go with the second option. The first option of sitting tight requires investors to refrain from emotional decisions. Therefore, the second option intuitively feels easier.
There is an important principle to understand here. If you wait out the storm and don’t sell, you really haven’t lost money. Your accounts may temporarily be down, but let us not confuse this with locking in a loss.
A recent example (which isn’t exactly related to the stock markets) is the real estate boom and bust of the early 2000’s. The rapid decline of home values was tough to stomach. If, however, an investor afforded themselves the time to wait, they would have been just fine. Trying to time the markets is a guessing game, no matter what market “experts” predict. None of us have THAT crystal ball.
My assertion on timing comes from the psychology of what has to occur. You see, things are good right now. The economy has all-time lows in unemployment. The GDP is stable and growing. Currently, we are also seeing record corporate profits. The person who gets out of this market is doing so because they are nervous. They simply can’t stomach a pull back. In other words, they are fairly risk adverse in relatively rosy times.
If that individual gets out of the markets during the best of times, how improbable will it be for them to jump back in during the worst of times? I assume a very slim chance. And, being in the business of financial advice for almost 20 years, I have yet to see it done.
As part of this topic, also think about the news headlines just before markets hit their top or bottom. For example, the graph below shows historic headlines at these peaks and valleys.
Remember our conservative investor? He (or she) would need to get back in the markets when economy sentiment hit all time lows. If an investor can’t stomach the idea of a pull back when markets are performing well, how difficult would it be to get back in after a 56% drop?
My experience
In the words of Peter Lynch, one of the greatest investors in U.S. history, “Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.” My experience tells me this is 100% accurate. It’s a big reason why we coach clients about emotional decisions. When long-term financial goals are at stake, the last thing you want is to make a rash choice
Again, Billy Joel sang, “You may be right, I may be crazy; you may be wrong for all I know but you may be right.” When it comes to the markets, this is exactly what happens when you start the timing game. I believe you need to create a strategy for management and not let outside influences throw you off course.
Remember, it’s much easier to wait out a correction then to guess when it will happen. I know it takes resolve, proper diversification, and usually guidance from professionals to simply wait it through. In my experience, this is the correct mindset of a successful long-term investor.
