Your Investments: Think out of the box

As global financial markets continue to be volatile, some investors either wait to invest or they sell all their holdings to get out of the market. Either of these decisions is made with the expectation that the market will continue to go down or the desire to wait for the market to start going back up.

Backward thinking?

Unfortunately, some investors have an inverted perception of risk. They tend to buy stocks when they have already appreciated significantly and sell them after they have already gotten crushed. However, this is the opposite of the golden rule of investing: Buy low and sell high.

What is market timing?

One important investment strategy is timing the market, where the investor decides on the best time to either buy or sell his portfolio. Market timers depend heavily on market trends, both historical and current. Portfolio managers and brokers often use market-timing strategies to try and increase gains for their clients. They claim that these timing strategies are more successful than other methods of investment.

Taken to an extreme, pure timing requires the investor to determine when to move 100 percent in or 100% out of one of the three asset classes – stocks, bonds and money markets. Pure timing, which is possibly the riskiest of market-timing strategies, also calls for nearly 100% accurate forecasting; since we are not prophets, this is something nobody can claim.

It’s time in the market, not timing the market

One of the biggest risks of trying to keep timing the market is the potential of “missing” the market. This occurs when an investor, thinking the market will go down, reallocates his investments and places them in more conservative investments.

While the money is on the sidelines, the market shoots up. This means that the investor has incorrectly timed the market and “missed” the best performing months.

There have been numerous studies done to illustrate how much an investor can lose by being out of the market. For example, if $10,000 were put in an investment that performed similarly to the S&P 500 Index from December 1990 to December 2005 and left untouched, this sum would have grown to $51,354 by the end of this time. However, if the investor missed even the 10 best days of the stock market during that 15-year period, his investment would have grown to only $31,994. And missing the stock market’s best 50 days during that time would have led to a loss; the original $10,000 investment would have been worth only $9,030 by the end.

Is now the time to be a contrarian?

With the market continuing to drop, we may ask whether it is a good time to buy right now. Investors who go against the general market trend are called “contrarians.” A contrarian is also defined as an individual who believes that certain crowd behavior among investors can lead to exploitable mispricings in securities markets.

For example, widespread pessimism about a stock can drive a price so low that it overstates the company’s risks and understates its prospects for returning to profitability. Identifying and purchasing such distressed stocks and selling them after the company recovers can lead to above-average gains. Conversely, widespread optimism can result in unjustifiably high valuations that will eventually lead to drops, when those high expectations don’t pan out. Avoiding investments in over-hyped investments reduces the risk of such drops.

While buying and selling constantly and trying to time the market are not always advisable, it is worthwhile remembering that there are always opportunities in the market, especially after it has dropped. When potential investments are analyzed objectively, without getting caught up in the pessimism that pervades the current investing climate, this could mean that now may be a good time to invest.

aaron@lighthousecapital.co.il

Aaron Katsman is a licensed financial adviser in Israel and the United States who helps people with US investment accounts.