Food for Thought from Marcia’s Retirement Kitchen
I gave a presentation about getting ready to retire and how to create income throughout retirement. Afterwards, a gentleman raised his hand and asked an interesting question. “The market just hit an all-time high again today. How much longer will the rise continue and when will the next recession hit? When should I adjust my portfolio, especially since retirement is much closer?” Really? Here’s a nice person who is trying to time the market.
He’s one of many who thinks there is an answer. He’s one of many who does not understand how the economics of the market work. This question illustrates how financially lacking in knowledge we are. Whether in public settings or private, this is one of the most common questions financial professionals get. And, it is a recipe for disaster if you try to make investment moves thinking you will be trying to time the market. No one know what the market will do tomorrow. No one.
Trying to time the market is a fool’s errand
We don’t know what will happen two minutes from now, let alone next week or next month or in 18 months. There is no crystal ball that financial professionals have. And, there is little value in spending your time thinking about trying to time the market. There’s no way to know when to get out of the market just before it declines. Or even when to get back in before it makes its next big climb.
Market timing is not a strategy. It’s a response to being over-invested in risky assets or overly emotional. This behavior creates bad buying and selling decisions. And unfortunately, leaves the near-retiree frustrated and concerned that he or she won’t have enough money for retirement. It’s unpleasant no matter how you slice it.
A simple recipe for investing success
The fact is if you want to build wealth or increase your retirement nest egg, there is a recipe. Most interestingly, it only has three ingredients. This is a recipe to avoid making risky moves. Yet still get to the end result you are looking to achieve: money to last through retirement. Here it is:
- Move money into investment accounts on a scheduled basis
- Set up an asset allocation strategy that’s well-diversified based on your appetite for risk
- Make strategic and tactical shifts only when there is a reason to do so.
Wait – where’s the chocolate in that recipe?
Sorry, no chocolate. Instead, these are key steps you can take to make sure you stay away from making a risky recipe that defeats the purpose you’re working toward. Here’s more information about each ingredient:
Your first ingredient
First, do not freak out over market ups and downs (particularly the downs). And have a plan that you like and understand in writing. For example, like everyone, you are saving for retirement. It makes sense to have some amount of your paycheck automatically diverted to your 401(k) or 403(b). This is an excellent first step. It’s the concept of paying yourself first. And where all investing best practices start. You are physically moving money into your investment accounts.
But where exactly is that money going? Into one mutual fund? Several different funds? To cash? Do you even remember where it’s going? When is the last time you checked?
That brings us to ingredient number two
Second, in order to decide exactly in which investments to put your money, it is critical that you understand risk. Risk is the likelihood that the market will decline. The net effect is you will lose value in your investments.
So, how much risk can you reasonably take on? The amount of risk you can handle leads you to the right asset allocation for you. This is simply the amount or percentage of your investments that are in equities (high risk), bonds (somewhat less risky), and cash (least risky). The amount of risk you can absorb allows you to avoid making rash decisions when the market is going crazy. The amount of risk you can handle with your money still lets you sleep at night.
The people who ask about trying to time the market, as this gentleman did at the seminar, clearly demonstrates a key lesson. That is, asset allocation is not set up to accommodate the level of risk they are carrying in their portfolios. In other words, if you are worried about a market correction you do not have the right asset allocation. The fact that your portfolio value may drop from say, $500,000 to $400,000 is a part of being an investor. If you can’t live with that, you aren’t in the right investments. Your asset allocation is too risky for your comfort level.
Like many, you may think you have to sell some investments to prepare for a looming market crash. If this is you, you may not have the right allocation in place. Your money isn’t in the right time-horizon goal “buckets”. In order for your money to grow, you have to be invested. Being invested means exposing those dollars to risk. Risk means your money is exposed to market corrections. Don’t sell when the market is low! And, more important, don’t panic.
Make sure your money is in the right “bucket”
That brings us back to the need to have the right asset allocation. Are you comfortable if 80% of your money is “riding the equity market”? Do you have 30, 40 or 50 years until you’ll need that money? Meaning, until you sell those investments and turn them into cash to live on? If so, you should be fine with a high equity position.
Equities are the investments with the highest potential to provide you with investment gains. But, you have to be prepared to see the value of your portfolio bounce around over those years. Over the long term, your value should increase based on both your ongoing funding of the account and market growth.
If, on the other hand, you are not comfortable losing real money when the next market crash comes, time to relook at your investments. You’ll want to see where you are invested too heavily in equities and switch to a more balanced portfolio. That means more of your money should be in bonds, CDs, and other less risky investments.
There is no such thing as risk-free when you are investing your money. Just more risk and less risk. We all lose value on paper at some points over the years. The key is to be comfortable with the decline. And to not make any panicked moves trying to time the market.
There will come a time to sell, but when is that?
That brings us to the third key ingredient:
When to sell and when to buy a particular investment is a recipe that is part art and part science. You really don’t want to sell in a down market when valuation is low. But that is what most people do. How do you avoid that? Let’s say your son is going to college and you’ll need to pay tuition for him. But, your portfolio is less than it was two years ago. Well, you made a critical mistake two years ago. You kept too much money in riskier investments rather than understanding that your time frame changed. If you need to write a check two years from now, or two months from now, the only safe investment is cash.
Again, we’re back to the simple fact that no one knows when the next market down turn will occur. Could it be tomorrow? Yes. Could it be 6 months from now? Yes. Could it be yesterday? Well, no!
Think about the physical nature of money. At some point you’ll want or need to spend it. If you quite literally need some of your savings in the next day or within the next three or four years, you need a bunch of cash readily available. The investment time horizon is over for that goal. The timing changed from say 20 years into the future to two years from now.
You’ve now moved into the spending zone. Make your strategic asset allocation shifts to work with your goals as the priority. How long till you buy that boat? Will Suzie be going to college soon? How long until you quit your job? The closer the deadline, the fewer risky assets you should hold.
Is there more to trying to time the market?
What’s the recipe for avoiding market timing? Is there a way to keep a feeling of confidence with your investments? One important way is to make tactical investment shifts about once a year. This puts your portfolio back in alignment to your asset allocation target mix. And, aligns with your time horizon for that particular bucket of money.
If, in order to meet your goals, you have figured out that you need a portfolio that is 70% equities and 30% bonds, that’s your target asset allocation. Or target asset mix. At tax time when you’re looking at all of your money, is your mix still 70/30? If not, you need to make tactical buy/sell moves to realign your money. That’s what actually keeps you on track.
Plus, the next time the market tanks, and it will, you will be confident that your investments are working correctly. And further, that your time horizon for these assets is far enough out there to absorb the downturn.
Trying to time the market is a risky recipe. Work with a financial advisor if going it alone isn’t your cup of tea. It can be too hard to get it right if you aren’t disciplined. Understand that market declines are not necessarily a bad thing. Remember, they are an opportunity to buy at a bargain price. Just like picking up extra chocolate when it’s on sale!
Resources when trying to time the market
Still think you can time the market, buying low and selling high? Take a closer look at some of the research that clearly shows most of us think we’re good at timing the ups and downs, but the proof is in the pudding via much lower valuation investment accounts!
- Why trying to time the market is a fool’s endeavor. “…stock market fund investor realized an average annual return of 3.7% per year versus the S&P 500’s 11.1% over the past 30 years. A $1,000 investment in the S&P made 30 years ago would be worth $23,583 today, while the average investor would have an ending balance of just $2,965.
- Yet Another Study Shows That Timing the Market Doesn’t Work “…A hypothetical investor with $100,000 would watch their investment grow to $249,000 (before taxes) over 20 years at a 4.67% annual rate of return. That same investor, earning, 8.19% per year [S&P annualized returns], would end up with $483,000 — nearly twice as much.