More on the Dangers of Market Timing

I remember reading an article in the Wall Street Journal about how, on May 20, 2010, Karen and Roger Potyk sold all of their stocks.  The comfortably retired couple from San Antonio, Texas had stayed invested in some equity mutual funds in the aftermath of the financial crisis of 2008. However, the ongoing market volatility following the “Flash Crash” on May 6, 2010 pushed them over the edge – and into bonds and CDs. That day, due to trading glitches, the Dow Jones Industrial Average fell 700 points in eight minutes before rebounding. The Potyks took that event as a sign that the market was market no longer for them, but run for the benefit of companies that were “too big to fail” and their powerful computers. The Potyks’ lack of confidence in the financial markets was no doubt exacerbated by the fact that they lost $75,000 in a Lehman bond when the firm defaulted.

But let’s look for a moment at the S&P 500 Index. On May 20, 2010, the day the Potyks sold their stocks, the S&P 500 Index closed at 1,071.59.  Last week, it closed at 1,648.36.  Ouch! Market timing doesn’t work.

Of course, the Potyks weren’t alone. In times of market stress and prolonged volatility, investors tend to retreat from equities. In 2002, for example, investors withdrew more money from mutual funds that invest in U.S. stocks than they put in. Then, from 2007 through 2009, during the recent recession, investors withdrew money from the market for three consecutive years. Notably, that was the first three-year period of withdrawals since 1979-1981, according to the Investment Company Institute.  And, in particular, we saw many investors flee stocks in the first quarter of 2009, only to miss one of the biggest historic increases in equities during the next few months of the year.

Of course, we don’t know what the Potyks did after May 10, 2010. It could be that they re-entered the market soon enough to participate in some of the remarkable upside. But, more than likely, if they re-invested, they waited far too long to get back in, committing the error that leads many individual investors to underperform the market over the long term. That is, we know they sold low, but when their emotions prompted them to re-invest, they more than likely bought high. Of course, that’s the exact opposite of the simple “buy low, sell high” advice that should govern your investment decisions.

Sure, that sounds easy, but it’s more difficult that you think. Buying low and selling high requires both the discipline to stick with your carefully developed asset allocation and investment policy statement and the ability to understand and reign in your emotions. The emotional part is important because greed often cause you to do just the opposite of what’s in your best interests.

Working with a trusted advisor can help you to think rationally and remain invested in a diversified portfolio for the long term. As the legendary Warren Buffett wrote in his preface to Benjamin Graham’s The Intelligent Investor, successful investing requires a “sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework.”

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