JumboCash: Timing the market

In the financial media, there has been a lot of speculation regarding a recession looming within the next 18 months. In the face of such uncertainty, you might be tempted to sell your assets before the market crashes, and once things pick up again, you believe you can safely invest and watch prices rise. However, the notion of trying to “time the market” is extremely detrimental behavior for investors, and it can be avoided through disciplined rebalancing.

To start off, let’s rewind to Jan. 15, 2016, when CNBC posted an article titled “A recession worse than 2008 is coming.” Suppose you had all your money invested in an S&P 500 Index Fund, and you decided to sell everything before the predicted recession hit; once things recovered, you would buy back your stock. 

Well, just 2 months after CNBC published their article, the S&P 500 was up about 8%. Fast-forward to today, and the S&P 500 has risen nearly 60%.

There are two key takeaways from this exercise. First, even for financial professionals, it is incredibly difficult to “time the market.” Sure, there can be indicators suggesting a recession, but trying to accurately and consistently act on that information is not a winning strategy — even when people are right, it is often due to luck.

Second, look at what happened when you took out your money. You expected the market to crash, which would allow you to keep your money in cash, avoid losses and repurchase your security for a lower price. Instead, the market rose a large amount! Not only did you miss out on a large gain, but now you have to pay a higher price to repurchase your security. To put it simply, you “sold low” and “bought high.”

So, how can you stay disciplined and overcome the urge to panic and sell? The key is portfolio rebalancing, which means adjusting the weighting of your portfolio to a target allocation.

Let’s say you have concluded that a portfolio of 50% stocks and 50% bonds will help you meet your financial goals. Let’s assume that the stock market did crash in 2016 as the article predicted, but the bond market remained unchanged. Because the values of stocks dropped, they now make up a smaller portion of your portfolio: your new allocation is 40% stocks, 60% bonds.

In this scenario, you should buy more stocks, returning your portfolio to 50% stocks, 50% bonds. If the stock market has risen and bonds remained unchanged, you would sell stocks to return the balance to 50–50. With such a strategy, you have “bought low” and “sold high,” all while retaining your original risk level.

Typically, it is valuable to rebalance monthly or quarterly. Rebalancing on shorter terms increases the amount of work you have to do, and trading frequently incurs higher costs, but waiting too long to rebalance could lead to “portfolio drift” — meaning the riskiness of your portfolio might not reflect your original intent. 

Next time you read about a market crash in the news, don’t try to time the market: stay disciplined and rebalance.