With the Australian share market near record highs, some people may feel reluctant to invest and prefer instead to wait until the outlook feels more certain. However the difficulty with this strategy is that there is generally an opportunity cost of not being invested, and no one has come up with a consistently successful strategy for timing the market. So whilst timing has a certain seductive allure to it, in truth there are far more sensible strategies you should use to tackle this dilemma (and reduce your anxiety levels!).
The truth is that for long-term investors who have a proper financial plan, these issues should be irrelevant. What matters is how their portfolios are structured and how they are tracking relative to their chosen goals.
Markets will forever go up and down based on the latest news and events. But in the long term, capitalism works its magic and equity prices generally move higher. For most of us, tyring to forecast the short term ups and downs just creates anxiety and risks a poor investment experience.
While nobody has come up with a consistently successful strategy for timing the market 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% in the market and 100% 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 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 long term strategic asset allocations if they are well on course to meet their goals.
So, for example, for some investors it may make perfect sense to lock in returns after a good period and change their investment mix by increasing their allocation to cash and bonds if that allocation will meet 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. This is particularly helpful when an investor is endeavouring to move from a largely cash position, to a fully allocated long term investment portfolio.
A useful contribution on this subject comes from Ken French, Professor of Finance at the Tuck School of Business at Dartmouth College. In his role as an academic, Professor French says the optimal decision is to invest it all at once. But while this might give an individual the best investment outcome, he says 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 and the price goes up.
Professor French says that 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 my 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,” he 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 into or out of the market. For instance, it would have been nice to get out in late 2007 and back in around early March 2009. 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.