Friday, August 10, 2007

Investing in the best of times, the worst of times

This from Robin Bowerman's Smart Investing today:

Sharemarkets are at record highs; must be a bad time to invest.

Markets are falling around the globe; must be a bad time to invest.

In a few short weeks market sentiment has shifted in seismic fashion. The threat of a credit squeeze around the globe plus the impact of the latest interest rate rise by our Reserve Bank sends mixed signals to investors.

The concerns about the slack lending practices in the US sub-prime mortgage market - the so-called "Ninja" loans (no income, no job, no assets) - is real enough and it has already had an impact directly in Australia with a number of funds having to declare their exposure or in one hedge fund's case suspend redemptions.

At times like this if you get a group of investors in a seminar room you could be certain that one of the main questions would be "is this the right time to invest?" Essentially people are looking to time the market - buy on the hope it is just a dip. Trying to time market moves is the oldest game in town. It is also involves two decisions not just one - the easy move is to sell when a market hits a record high the harder call is when to buy back in.

And the problem for investors is that often the biggest moves in sharemarket value - both up and down - are clustered together. We saw that again in the last week. A big fall on Wall Street followed a couple of days later by big rise on Wall Street. The yo-yo effect was dramatic.

For those old enough to remember the sharemarket crash of October 1987 it is a salutary reminder of how hard it is to time big market moves. It is probably no surprise that research over 20 years of daily moves in the Australian sharemarket found that between 1977 and 1997 eight of the 12 worst days for our sharemarket were in October 1987.

What generally surprises people is that six of the eight best days for sharemarket gains were clustered around October 1987. Now by most people's definition if you had managed to be out of the sharemarket in October 1987 that would qualify you for hall of fame status as a market timer.

But you would have missed some significant market gains and over the long-term possibly had a lower return overall. Past performance is certainly not a reliable guide to future market performance but it can be useful to remind us of mistakes or emotional over-corrections.

One of the best attributes any investor can have is discipline. The discipline to stick to a financial plan and investing within the asset allocation limits that your risk tolerance dictates...