How to avoid the market timing trap
In a post-Brexit bounce over the past few weeks, the major North American stock markets have touched record highs. That blindsided many small investors who had bought in to the end-of-the-world style of media hype right after the Brexit vote and jumped out of their equity holdings. Of course, they pretty much missed the almost immediate rally, which recovered the losses and sent markets surging to new highs. So is now the time to buy stocks again? Actually, that’s the wrong question to ask.
The right question
The right question is not whether now is the right time to put money into stocks; rather, it is, “If your portfolio doesn’t already include stocks as part of an asset allocation strategy, why not?”
In fact, anytime is the right time to get into stocks. You should always have some allocation to equities, and if you don’t, you’re doing something wrong. You should also always have bond holdings. And cash. In other words, you should have a plan.
Proper asset allocation is one of the keys to investing success. Basically, this means that you determine what kind of investor you are, what your financial objectives are, how much risk you can really stand, and then create a portfolio of investments that reflects that profile.
You might, for example, be a growth investor with a more aggressive outlook and willingness to take on more risk, and allocate, say, 10% of your portfolio to cash, 25% to fixed income, and 65% to stocks. And you’ll stick to roughly this allocation through thick and thin. You’ll always have a largeish portion of your holdings in equities, but you’ll also have bonds to help mitigate risk and provide income, while your cash gives you flexibility.
What about bear markets and corrections?
The S&P/TSX Composite Index recently went through a correction – that’s when the market falls 10% or more from its recent high before recovering again. It’s bound to happen again. But no one knows exactly when or by how much. Trying to guess market tops and bottoms is called “market timing” and no one ever gets it right, except by sheer accident.
When you have a planned asset allocation strategy that you stick to, you’ll feel more comfortable weathering the inevitable stock market downturns. Yes, the equity portion of your portfolio will plunge right along with the market. But your bond holdings are likely to soar, offsetting losses in equities. That’s called mitigating risk.
And that’s why I tell clients they should be in stocks, bonds, and cash at all times, instead of switching in and out of assets at random based on the headline of the day. It’s a matter of degree – allocating your asset mix according to your objectives and tolerance for risk. The market hits a record high? It plunges 10%? So what? Investing is a long-term business, and you’ll have a much greater chance of success in the long term if you have a plan…and stick to it.
© 2016 by Robyn K. Thompson. All rights reserved. Reproduction without permission is prohibited. This article is for information only and is not intended as personal investment or financial advice.