Kristina Hooper, US investment strategist and head of US Capital Markets Research & Strategy for Allianz Global Investors. She has a B.A. from Wellesley College, a J.D. from Pace Law and an M.B.A. in finance from NYU, where she was a teaching fellow in macroeconomics.
Timing the stock market can be a dangerous game that long-term investors should avoid playing. Not only is it difficult to get it right, but the time spent on the sidelines waiting for “the right moment” could pose big risks to your portfolio.
Stocks continued their winning streak on Friday, capping a two-week rally that saw investors cheer new Fed Chair Janet Yellen’s testimony and overlook some weak economic data. In fact, it was the best week for stocks we’ve seen so far in 2014. In January, investors seemed gloomy on the stock market but lately their outlook has been more upbeat. That shift in sentiment is likely being driven by an easing of risks to the recovery, specifically lawmakers’ efforts to avoid another debt-ceiling showdown. In fact, the president signed a bill lifting the debt limit on Saturday, freeing up the Treasury Department to borrow regularly through March 15, 2015.
A Fickle Lot
What a difference a few days make, not just for performance but also for fund flows. Investors reportedly pulled a record amount of money out of US equity funds and put a record amount of money into US bond funds for the week ending Feb. 5. That followed significant equity fund outflows for the week ending Jan. 29, according to Deutsche Bank citing EPFR data. However, in the past week, likely due to the turnaround in the stock market, more than half of that move was reversed.
Still, the volatility in weekly fund flows serves as a reminder that markets can be fickle and that investors may be doing themselves a disservice by letting short-term market gyrations affect their investment decisions. In fact, given recent volatility, Allianz Global Investors’ Economics & Strategy Group, which analyzes economic and capital-market trends, took a fresh look at the effects of market timing on an investor’s portfolio. We found that timing over longer investment horizons can lower returns by missing high-return days when moving in and out of the stock market.
Time In the Market
Specifically, Allianz Global Investors looked at the performance of the Datastream US Total Market Total Return Index from 1973 through the end of 2013, comparing four different investment approaches:
||Investing $100 at the start of the first year and adding an additional $100 at the start of each subsequent year.
||Investing $100 on the day of the lowest index level of the year and adding an additional $100 each year on the day of the lowest index level of that year—the best day of the year to invest.
||Investing $100 on the day of the highest index level of the year and adding an additional $100 each year on the day of the highest index level of that year—the worst day of the year to invest.
||Investing $100 each year at the start of the year as in the first approach, but assuming one misses the returns of the best three trading days in each year.
The result? The returns are actually quite similar for the first three approaches. The first approach yields an annualized return (adjusting for all the $100 injections) of 11.6% while the second approach yields an annualized return of 11.9%. The third approach produces an annualized return of 11%. While these approaches are all within striking distance of each other, the hypothetical fourth approach produces dramatically lower performance: an annualized return of just 1%.
A Fool’s Errand
The key takeaways from this study are simple: Investors with long time horizons would be wise to avoid timing the market because our research shows that it doesn’t make a significant positive impact on performance in the long run. And market timing can lead to poor results. For example, investors can miss the best days in the market in a given year, substantially reducing their overall performance. On the other side of the coin, missing the worst days in the market could improve overall performance. However, it’s unlikely that investors would guess correctly.
So, for those who already have adequate exposure to stocks, it’s not a prudent investment decision to time the market and move out of stocks with each little correction. You may find that you’ll re-enter the stock market at higher prices. After all, it’s nearly impossible, if not impossible, to perfectly time the market. And if you don’t have enough exposure to stocks and you’re looking for an attractive entry point, worry less about the actual timing. Rather, consider rotating into stocks. Why? Because the biggest risk may be not having exposure and missing out on the best days. In short, our research confirms a key message we’ve been trying to impart to long-term investors: it may be too risky not to be in risk assets.
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