Dance with the one that brung ya

Or, as a college friend of ours so memorably proposed marriage to his sweetheart: “Stick with me babe, and you’ll be farting through silk.” Happy Valentine’s Day, everyone!

Stay with stocks—it pays.

market_timing

Shania Twain sang: “You’ve got to dance with the one that brought you . . . and you can’t go wrong.”

A debate rages in many investment circles abut the merits of market timing. That’s the practice of buying and selling investments according to your outlook for the stock market in general. But take a clue from equity mutual fund portfolio managers. When did you last see a fund with more than 30 per cent in cash?

Equity mutual fund investors rely on their portfolio managers to pick stocks. And most portfolio managers keep a large percentage of their funds invested at all times, refusing to time the market. But you may be tempted to get in and out of stocks according to your (or some pundit’s) guess about the market’s future. We know of few who can consistently foretell the market’s fortune for any significant amount of time.

Statistics add insight

A recent study undertaken by the huge US mutual-fund company Fidelity helps illustrate the pitfalls of market timing.

The company examined the US S&P 500 large-cap index for the 38 years from 1980 to 2018. Over that period, the index was open for trading on roughly 10,000 days. And $10,000 invested in the index at the beginning grew to $708,143 after 38 years.

If a hypothetical investor missed the five best days in those 38 years, her $10,000 would have grown to just $458,476. If she missed the best 10 days, her initial investment grew to only $341,484. By missing the best 30 days, the investment grew to $135,226, and by missing the best 50 days—just over one day each year—that investment grew to only $62,342.

That amounts to a compound annual growth rate of just 4.9 per cent. By contrast, had you remained invested throughout the period, your annual growth rate would have been 11.9 per cent.

The costs of being out of the market

The problem for market timers, then, lies in guessing when those few best days will be. Often an investor will sit out a bad period in the market, only to miss some of the best days when the market rebounds after a fall.

In addition to the risks of being out of the market, trading incurs transaction costs, and results in income taxes payable (outside a registered account) every time you realize capital gains with no capital losses to offset them.

We recommend taking a long-term approach to investing. When you buy shares of an equity security, plan to hold indefinitely. You may decide on different investments each time you have new money to invest, but don’t sell and expect to buy back cheaper on a consistent basis.

There are generally only three times when it makes sense to sell. The first, of course, is when you need the money for something else. The second is when you re-balance your portfolio or change your asset allocation as you age. The third time to sell an equity security is when something is fundamentally wrong with it.

Other than these three special occasions, we suggest holding your equity investments indefinitely, and resist the temptation to try to outguess the market—it seldom works.

This is an edited version of an article that was originally published for subscribers in the January 17, 2020, issue of   Money Reporter. You can profit from the award-winning advice subscribers receive regularly in Money Reporter.

Money Reporter, MPL Communications Inc.
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