QUESTION:
I have about $93,000 invested in non-retirement mutual funds. I have been considering trying to time the market by selling these funds when I sense a bear market approaching (incurring a $1,700 capital loss), and then buying the same funds at a cheaper price once the bear market has arrived. I have no debt and an emergency fund. Is this a good strategy, or too risky?
For all practical purposes, market timing is a gimmick, rather than a sensible investment strategy. Similar to stock picking, the likelihood of success is very low and you are far better off with a disciplined long-term investment strategy that ignores short-term market dips and swings. Don’t get me wrong, market timing does create the opportunity for outperformance; however, with that opportunity comes the incredible risk of missing out from capturing market returns when it really matters. For example, missing just the 25 best single days from 1990 to 2017 would cut your S&P500 annualized compound returns capture in half, from 9.81% to 4.53%. And, during the last financial crisis of 2008, investors who simply stuck with their investment plan did far better than investors who got out and then tried to get back in.
What about the professionals? Unfortunately, the track record of these so-called market gurus is no better than that of the lay investor, nor for that matter better than that of a dart-throwing monkey, and on average is worse than a flip of a coin (feel free to get in touch for references). So, if the professionals can’t consistently time the markets, why would you even bother?
Maybe there is an explanation for this as well. You asked whether you should sell mutual funds when you “sensed” a bear market approaching. From behavioral finance we know that investors are not wired for disciplined investing, and that they also tend to be overconfident in their supposed investment skills. Framing your trading decisions based on your “sense” that a bear market is approaching falls under both of these biases. Discipline is most certainly not about “sensing”; however, overconfidence in your abilities certainly is.
To build wealth, an investor should stay in his or her seat, ignoring the daily financial weather (market dips and swings). Concentrate on the long term financial climate instead (growth of wealth over time).