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Question:


What’s the danger of using a market timing strategy? It’s worked for a couple of my buddies.
-MarketWatch


Answer:


The danger is that you’ll get it wrong, buying near a market top and selling near a bottom. No doubt you’re thinking you won’t do that, that you’ll get in close to the bottom and sell close to the top. Buy low, sell high, right? Right, except that there is plenty of evidence that investors don’t do this. Among the most tried and true forecasting tools for the stock market are sentiment indicators, or surveys of investors’ views of the stock market. When a lopsided proportion expect the market to go in a particular direction, it tends to head the other way.
 
This pattern has been found using surveys of amateurs professionals alike. The reason that it pans out this way is not that investors are error-prone nincompoops. What it comes down to is that when people say they expect a particular outcome, they position their portfolios that way, causing the market to move in that direction. As more investors make the same bet, fewer are left to follow in their footsteps, so the trend changes.
 
A study by TrimTabs Investment Research confirms that mutual fund investors are typically out of sync with market movements, catching the downturns and missing the recoveries. TrimTabs found that while the average level of the Standard & Poor’s 500 index, the main benchmark of U.S. stocks, was 1,171 in the 10 years through July 2010, the average dollar was invested in stock funds at an index level of 1,434. Awful timing, to say the least.
 
As for your friends’ success, they may be far better market timers than the average investor. If so, buy them lots of dinners and keep pumping them for advice. More likely, they enjoyed beginner’s luck or have selective memories. The best strategy for most investors is to maintain a portfolio balanced between stocks and bonds in a ratio of around 60/40 or, if you’re fairly young and can afford to take more risk in exchange for the chance to earn higher returns, 70/30. Then hold on for the long haul, while rebalancing periodically – selling a portion of whichever asset class has gone up in price and buying the weaker one – to restore the desired weightings.
-Conrad de Aenlle



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