It’s hard to believe now, but not long ago economists were congratulating themselves over the success of their field. Those successes — or so they believed — were both theoretical and practical, leading to a golden era for the profession...Last year, everything came apart...
Sunday, September 06, 2009
Friday, September 04, 2009
Jim Parker, Regional Director, DFA Australia Limited
Just six months ago, millions of would-be investors were reluctant to move into equities because the market was falling too fast. Now many are wary because the market is rising too fast. In the meantime, life moves on.
Any financial advisor will recognise the syndrome. It's like watching a child standing tentatively at the edge of a swimming pool. She's torn between her desire to join the gang and her fear of getting cold and wet. But if she leaves it too long, she misses the opportunity altogether and it's going home time.
In retrospect, of course, it would have been better to get out of the equity market completely in October 2007 and move into cash and government bonds, before reversing course again in early March 2009.
The reality is that correctly timing your exit and entry to the market is impossible. If it were as easy as some claim, millions would be doing it and getting very rich in the process. Some of us would be writing books about it and going on TV business shows to promote our "timing secrets".
The reason timing stories are back in the news is because some analysts and commentators are questioning the sustainability of the recent rally in share markets. With major indices 40-50 per cent or more above their March lows, the word is that valuations are no longer compelling and that the economic recovery will be a sluggish one.1
Others go further and say this is a "sucker's bounce" in a longer-term bear phase that could take the market back below the March lows. These bears are nervously eyeing October, traditionally seen as a shaky time for markets.
It's no wonder, then, that some nervous investors who missed the March-to- August rebound are now afraid of getting in because they think the market is too elevated, while others who stayed invested are wondering whether they should take some profits off the table.
At one end of this emotional spectrum of investing is regret about what has already been lost. At the other is a combination of fear and greed at what the future could hold. All of these feelings are understandable and reflect the fact there will always be uncertainty in investing. With return comes risk, after all.
But while no-one yet has come up with a consistently successful strategy for timing the market to perfection, there are some things that everyone can do to help ease the anxiety they feel about investing.
One is to realise that it does not have to be a choice between being 100 per cent in the market and 100 per cent outside. Ideally, an investor should stick to their strategic asset allocation — be it 70/30 or 60/40 or 50/50 equity/bonds.
Another is that this strategic asset allocation can be combined with periodic, disciplined rebalancing, in which the investor shifts assets from well performing asset classes to those less favoured. This is a good way of controlling risk without necessarily trying to time the market.
A third option is that there is nothing wrong with investors taking into account the returns they have already enjoyed and adjusting their asset allocations if they are on course to meet their goals. So, for example, for some investors it might make perfect sense to lock in returns after a good period and put the money into short-term fixed interest if that meets their needs.
Yet another option is dollar-cost averaging. This is a method where an individual invests small amounts of an available pool of cash into the market over a period, rather than investing a lump sum in one go.
Dartmouth finance professor and Dimensional director Ken French tackles this subject in a recent video interview. From his standpoint as a professor, French says that the optimal decision is to put all of the money into the market today. But he adds that while this might give an individual the best investmentoutcome, it might not be the best investment experience.
This is because people tend to feel regret more strongly when it results from things they did do than from things they did not. So, for instance, it feels much more painful to buy stocks now and see the price go down than it is to neglect to buy stocks (like back in March) and the price goes up.
French says by dollar cost averaging, people can diversify their "acts of commission" (the stuff they did do) as opposed to their "acts of omission" (the stuff they didn't do).
"The nice thing is that even if I put finance professor hat back on, it's really not that damaging to your long-term portfolio to just spread it out over three or four months," French says. "So if you as an investor find that's much more tolerable for you, you're not really doing much harm."
So, in summary, it's always difficult to choose exactly the right time to get back into the market. Ideally, it would have been nice to get out in late 2007 and back in around early March this year.
But most mortals are unable to finesse it to that degree. The good news is that there are other options than just staying out of the market altogether and plunging back in.
These include maintaining a long-term strategic asset allocation in the first place, periodically rebalancing, taking money off the table if retirement goals are on track and dollar-cost averaging if that provides comfort.
The underlying philosophy in all these options is that individual investors are making decisions based on their own needs and risk appetites, not according to someone else's opinion as to what the market does next.
Uncertainty will always be an integral part of investment (and life). But there are many things we can control. And this is where a good advisor comes in.
1'Valuations No Longer Compelling: HSBC', Global Investment Views, August 2009