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The Science of Hitting
The Science of Hitting
Articles (623) 

From Long-Term Investing to Market Timing

Some thoughts on handling short-term volatility

March 09, 2020

I work for an investment advisor. While I personally find great enjoyment in the analysis of individual securities, I think that’s a small part of the value add that we offer to clients. What is more important, in my opinion, is helping people understand the need for an appropriate asset allocation that will enable them to effectively manage their financial and mental well-being (their emotions) throughout market cycles. We emphasize the importance and the eventual rewards of a long-term perspective when it comes to equity (business) ownership, supported by historic data such as the below graphic.

Most clients seem to buy into that approach... until markets start to move. When outsized daily market movements - particularly to the downside - start to feature prominently on the night news, investor behavior changes. Suddenly, clients that were fine with a certain equity allocation a week ago have concerns that they’re too exposed to the market. Once they’ve already “lost” 5% or 10%, they want out. While advisors typically do their best to discourage this reactionary behavior, sometimes they will not be successful (or they’ll conclude that it’s in their own self-interest to do what the client dictates, even when it may not be in the best interest of the client). Many of us may become convinced that we need to do something to deal with market volatility.

Here’s my problem with this mindset: first, it assumes that these kinds of short-term swings are actually predictable (they’re not). Second, it never ends with that first decision. Consider a client who decides to reduce their equity allocation on Monday after seeing a bunch of scary headlines – and losses in their portfolio - over the past two weeks. Suddenly, they’re looking to Mr. Market’s daily activities for answers. A continued sell-off over the next week or two will provide a sense of accomplishment. However, even if you guess short-term movements correctly, the game doesn’t end there. Now you need to make another decision. Should you sit tight, sell even more, or get back into the market? This scenario plays out at every turn. Regardless of whether stocks are trading higher or lower, it’s the same question: now what?

In the end, this becomes a game of trying to outguess other market participants on the next move higher or lower. It turns what used to be a portfolio into a guessing game based on unsubstantiated hunches. It becomes all about market timing, and it’s an approach that is likely to generate lackluster results over the long run. I can think of many investors who have made vast fortunes in the stock market, but few, if any, have done so by focusing their efforts on market timing.

Many fall into the trap of thinking that they’re protecting their savings by tinkering with their asset allocation, but they’re generally doing the exact opposite. They are forgetting about the chart shown above, which indicates that, over the long-term, the ups and downs take care of themselves and ultimately result in attractive returns. That only works out if you’re able to accept short-term volatility (especially losses) and stay invested for the long-term. In an attempt to avoid unattractive short-term results, investors all too often set themselves up for unattractive long-term results.

Disclosure: None

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About the author:

The Science of Hitting
I'm a value investor with a long-term focus. My goal is to make a small number of meaningful decisions a year. In the words of Charlie Munger, my preferred approach is "patience followed by pretty aggressive conduct." I run a concentrated portfolio - a handful of equities account for the majority of its value. In the eyes of a businessman, I believe this is sufficient diversification.

Rating: 5.0/5 (6 votes)



Efactor - 2 weeks ago    Report SPAM

I'm practicing market timing. Unfortunately, I have little cash inside my IRA's to deploy, so as we get these double digit loss days, I'm doing transfers-in-kind of my stocks from my Traditional IRA to my Roth IRA. Rather than be upset with the paper losses in some cases, I feel good about having the opportunity to move so many of them over to the Roth. So, in this way, the cash held in the bank is king!

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