The Classic Question: Timing the Market
“Is this a good time to buy?”
This is, without doubt, the investing question I get asked most often (spoiler alert: I never know the answer). The appeal behind timing the market is tied to the age-old adage of buy low, sell high. History has proven that investing for a sufficiently long time frame, no matter the start and end points, will accomplish this goal. To evidence this, the S&P 500 has, for example, never had a 10 year period in its history that produced a negative total return. By turning this into an iterative process, investors hope to compress decades of returns into much shorter time periods. It sounds simple, but is this a feasible strategy for investors to employ?
From a short-term perspective, timing the markets is akin to day trading (something I covered in a different piece here). For the purposes of this piece, I’ll be speaking to the process of deploying a large sum of money into the markets at once (be it a windfall, an inheritance, a bonus, etc.). For many market participants, this is as much of a psychological decision as a strategic one.
Can You Determine a “Good Time” to Buy?
It can be tough to turn a pile of cash into investments and it makes sense to want to buy at a good price. But equities and bonds aren’t the same as goods and services; they are not purchased for tangible value, but rather to capitalize on anticipated appreciation and the cash flows that they produce. Determining what is a “good” price is like trying to hit a moving target while blindfolded. An investment’s price is theoretically its future cash flows discounted at a relatively arbitrary rate to determine its present value. Think of how many assumptions go into deciding these prices. What if cash flows are different than anticipated? What should the discount rate be? Then you must consider the investor sentiment aspect, which ultimately drives prices. Investment theorizing involving high-level calculus has been developed to try to determine how these factors interact to determine fair asset prices, and still the models inevitably fail.
History has proven that the market is, at times, overvalued and undervalued at others, but history is in the past, and the hindsight bias associated with using it as a guide has been the root of a lot of irrational investing behaviour.
Consider the Risks
You must also consider the consequences of betting wrong. If you believe the market is overvalued and you are therefore waiting for a dip in order to buy, how will you behave if the market rallies further instead? Will you continue waiting for the market to drop some arbitrary amount? Will you try to hold out until the market drops to your original price target? You may end up sitting on the sidelines for a long time. In today’s low interest rate environment, returns on risk-free assets are virtually non-existent. For most investors, there is no alternative to investing funds in accordance with their risk profile (the combination of their willingness and ability to take risk and their time horizon) and hesitating to do so will be of no benefit.
Still Nervous? Consider Buying in Tranches
If you are nervous to deploy a large amount of cash into the markets in one fell swoop, then invest it strategically in tranches. I’ll admit that I’ve thought the market was due for a pullback or a rally on occasions, but I wouldn’t be willing to take significant financial risk based on this. Putting a large sum into the markets in tranches doesn’t need to be a complicated process; it can be as simple as investing 25% of the money at the beginning of each month. This is simply hedging your bets as you’re allowing for gains to be realized if the market moves in the direction that you anticipate it will, but you are still acknowledging the inherent unpredictability in prices.
Conclusion: Timing the Market
If market timing is still an activity you want to engage in, at the very least tie your decisions to something fundamental – whether it’s the market crossing below its 200 day moving average price level or the P/E ratio dropping to a certain level. Nothing screams uninformed investor more than someone telling me that the market “feels” overvalued right now. If your arthritic knee starts aching every time the market is about to pull back 5%, then lucky you, but you should still consider something more reasonable, such as prioritizing metrics over sentiment… or your arthritic knee.
Stay calm, stay patient, and remember that time in the market is more important than timing the market.
Opinions are those of the author and may not reflect those of BMO Private Investment Counsel Inc., and are not intended to provide investment, tax, accounting or legal advice. The information and opinions contained herein have been compiled from sources believed reliable but no representation or warranty, express or implied, is made as to their accuracy or completeness and neither the author nor BMO Private Investment Counsel Inc. shall be liable for any errors, omissions or delays in content, or for any actions taken in reliance. BMO Private Investment Counsel Inc. is a wholly-owned subsidiary of Bank of Montreal.
