This topic is as incendiary as religion and politics but it impacts every investor in the market, even 401k plans. But first, let's expose the shysters and frauds. No one can predict the future! Many claim that their scientific system will do that. Nobody's systems can predict the future. When we say “market timing” we are NOT referring to these schemes or systems. Avoid them like the plague.
There are two common investment strategies promoted by opposing camps. One promotes time in the market while the other promotes market timing. Both strategies employ the solid investment practices of asset allocation and diversification. After that they quickly diverge. Let's try to look at both objectively. (In this article we will assume the investment goal is retirement since everyone should be concerned with their retirement.)
Time in Market (TIM)
A generic time in market strategy promotes the use of dollar cost averaging to invest in typically an Index fund coupled with a Buy & Hold approach. The time in market camp assumes a long term commitment, typically 20-30 years with longer being better, over which time general market appreciation occurs. The TIM camp advises against trying to time the market because most investors time the market based on their emotions. Investor emotions have been proven to be wrong most of the time so this advice is well founded. The time in market strategy is the one promoted by financial professionals for non-professional investors. The greatest advantage of TIM is that it's relatively simple and easy to implement. The greatest disadvantage is that the compounded return will vary greatly depending on when you started invested and when you must retire.
Market Timing (NYSE:MT)
A generic market timing strategy promotes buying quality investment vehicles when they're cheap and selling them when they're expensive. When successful, the sale yields a profit which allows you to beat the general appreciation of a market index. This approach typically uses fundamental and/or technical analysis to make the buy and sell decisions. The market timing camp assumes neither long or short terms of commitment as everything is based on the buy and sell decisions. The market timing strategy is used by professional investors to maximize returns. The greatest advantage of MT is that you can realize significantly better returns in a shorter period of time. The greatest disadvantage is that you can lose significantly more in a shorter period of time.
Which is Best for Me?
The important question is which strategy will work best for you. The simple answer is “Probably neither.” TIM typically fails because most of us start too late and fund our retirement with too little. Throw in a market like we've seen the past few years and a lot of baby boomers are worried. MT usually fails because it's too complicated and time consuming for the average retirement investor. After all we have full time jobs already. So what is the answer? Simple, take the best of each and create a hybrid strategy. What does that strategy look like? It's a TIM approach where data driven buy and sell decisions replace the Buy & Hold approach. The general principles for self-directed retirement investing using a hybrid strategy are:
- Keep it simple
- Focus only on a few broad indices related to global financial markets and ignore everything else. Use funds to invest in these indices.
- Understand and act according to your long-term investment strategy.
- Be patient and avoid being greedy.
- Minimize all costs and expenses
- Brokers – use the least expensive, on-line broker that provides the minimum services you will need. You will never use 85% of the services they try to sell you.
- Funds – select index funds with minimum expense ratios and fees.
- Taxes – use a long-term trading strategy so that most gains will be taxed as long-term capital gains.
- Use Exchange Traded Funds (ETF)
- They offer every option you need for the least cost.
- Index ETFs are NOT managed by humans which is a good thing.
- They are readily available from reputable mutual fund companies that have been around for a long time.
- Use an objective, data-driven timing model service rather than emotion to determine your trades.
- Many studies have shown most humans are lousy deciders of when to buy or sell. They typically buy high and sell low.
- Even when imperfect, a computer trading model will make unemotional decisions. These dispassionate decisions tend to yield better results than emotional ones.
- Select only a service that submits to an objective, third party verification.
Upcoming articles will focus on the specific investor tasks to implement a hybrid strategy. Including but not limited to:
- Open an IRA account with an on-line broker
- Transfer your 401k money to the new IRA account
- Determine how much money to invest in each asset class
- Buy Index ETFs in amounts to match each asset class proportion
- Subscribe to a long-term, data-driven “buy & sell” model service and follow their signals
- Re-balance your ETFs to match your target asset allocations as determined by your long term goals.
The hybrid strategy can even be applied to employer managed 401k plans with slight modifications.
Disclosure: No current positions