Is it a smart thing to time the market?

‘I never have the faintest idea what the stock market is going to do in the next six months, or the next year, or the next two. ‘
 Warren Buffett

Timing the market is a luring strategy that many investors fall for including the even sombre buy-and-hold ones during prolonged bull or bear markets. It’s enticing to catch the next big investment wave (up or down). In the past few years (2007 until now) and from our previous experiences we have often seen how after a long advance, and often against their better judgment, people jump in to make what seems to be easy money. Conversely, during an extended decline they cannot bear the pain of increasing losses and bail out at the worst possible time.

Emotion and hindsight, always dangerous in the stock market, override common sense and fundamentals. Determining the right time to buy and sell requires as much good luck as good judgement. More often than not, ‘market timers’ sell when a market is low and are out of the market when the inevitable rally occurs.

You gotta be in it to win it

Over the past few years equity markets have turned very volatile; some or the other bad news from global markets affect Indian market sentiments, inflation had seen a persistent problem since a very long time, the economy’s growth rate plummeted from 8-9% to less than 5% now and with elections just around the corner the speculations add to the volatility. No one knows in such scenario where will the markets be headed. Some ‘experts’ are advising to invest in dips or wait till the markets have bottomed out while others thing this is the right time to invest.

But who would know when the markets have bottomed out? And who knew when the markets would peak?

Today great uncertainty prevails and most investors are at a complete loss as to how they should respond to markets like these. With the global uncertainty, although the world remains an insecured place, life goes on. Most of the people will still go about their daily business, getting up in the morning, having tea or coffee and going for work or looking after their homes. It is therefore important to remain committed to a long-term investment strategy. The world remains inherently and fundamentally the same. Bull markets have always been followed by bear markets, and vice versa. But good companies deliver good returns despite the market, in the long run.

When you invest in equities, the safer path is sticking to investing in solid, well-researched companies that fit your requirements for growth, earnings, income, and so on. If your company’s fundamentals are healthy and the prices do not deviate with the fundamentals you should hold on to your investment regardless of what direction the market is moving in. However, if you have a better option available you should switch your holding after a thorough research and analysis.

Is this the right time to invest? No one knows. When you have funds to invest, do not wait for the ‘right time’, as you may never know when the right time may come and go. The cost of waiting for the perfect moment to invest far exceeds the benefit of even perfect timing. And because timing the market perfectly is, well, about as likely as winning the lottery, the best strategy is not to try to market-time at all. Instead, make a plan and invest as soon as possible.

The key is that, when you decide to invest in stocks, do it. Don’t dither. No one can tell what will happen in the short term, but in the long term, equity investors profit.

The need to diversify

The simplest way of incorporating market timing into investment strategies is to have the right mix of assets – stocks, cash, bonds and other assets – in your portfolio, depending on your risk profile and time horizon. This is critical. Especially at times like these the importance of a well-diversified is understood. As we’ve discussed, timing your investments is not usually a sound investment strategy. The right thing is to diversify your money across a range of asset classes and to ride out the performance troughs in each market. When you invest your money in a number of asset classes, the good returns you receive from one investment in a certain time period can help offset the poor performance of another.

We often emphasize investors to maintain a portfolio that is well-diversified across and within the asset classes. But when the equity markets are surging, making and breaking record highs, the only investment consideration is for equities. Even the most risk averse investor’s portfolio will be biased towards equities. Conversely, when the sentiments are not positive and markets turn extremely volatile {times like these?} everyone wants to get out or stay away from equities. Fixed deposits, gold and bonds become investor’s favourite investments.

After the correct asset allocation has been decided upon, you need to diversify your investments by investing in a range of regions, sectors and industries and thereafter it is very important that you monitor and rebalance your portfolio regularly. Rebalancing your portfolio is crucial – when the returns from the equity side of portfolio increase causing the equity percentage in your portfolio to go up, you can rebalance your portfolio, to the earlier determined asset allocation based on your need and risk profile, and reduce your equity holdings. So when the markets tumble, you will realize that you have already taken the profits and invested it in other safe assets. Similarly, when the equity markets tumble you may find the equity part of your portfolio falling below the allotted levels and hence increasing your equity holdings will optimally balance your portfolio.

If your asset allocation is correct and your portfolio is properly diversified, patience is the only remaining ingredient for success. All asset classes experience market downturns – but investors who maintain proper asset allocation and sit through the phases with the right strategy are rewarded. As we say: it is not timing the market, but time in the market that counts. Trying to time the market is dangerous to your long-term financial health.

To sum up, a winning strategy therefore depends on a) proper asset allocation and b) acumen for choosing right stocks, no matter whether the market is near a bottom or top or in between, and holding on to it until you have a better option available.