Stock Market Timing vs Buy and Hold II

There has been a lot of press lately about the buy and hold philosophy. Based on the name of my site I think you know where I stand. It is also more than a bit ironic that I would quote Ben Graham, but some quotes are timeless. I do believe in the underlying principles outlined in his classic Security Analysis. Somewhere along the line value investing got confused with buy and hold. The confusion probably started when Wall Street still needed to sell stocks when they were not a bargain by any stretch of the imagination. That is probably when people started referring to Warren Buffet as a buy and hold investor. Wrong, he is a value investor that is well aware of the tax ramifications of an actively managed taxable account. Value investing is best suited for your taxable brokerage accounts. Most investors probably lack the time and or dedication that are required to research enough stocks so you can have a well-diversified portfolio. The vast majority of individuals have the bulk of their investments in some type of tax deferred retirement account. That is why my focus here is on market timing in your tax deferred accounts.

All that being said, I have been getting a kick out of the arguments made by long-term buy and holders.

Some of the major defenses of buy and hold have a hint of market timing to them. If you are buying cheap and selling dear is that not a form of market timing. Your indicator du jour might be a P/E ratio instead of a moving average but you are still making a prediction about the future price of an individual stock. The funny thing is you would be hard pressed to find a long term buy and holder that thinks he or she is timing the market. I would venture to guess that they would loathe the thought of trying to time the market.

I also see a lot of people saying that because there is so much talk about buy and hold being dead that is the exact reason it is probably not dead. There may be some truth to this in that it is best to probably zig if everyone else is zagging. However that in it self a form of market timing based on sentiment. I wouldn’t buy something just because it is out of favor. For me I need to see positive fundamentals and good price behavior. I am sure at some point in time, on its way to zero, the sentiment for Enron may have made it look like a good contrary investment.

Professional fund managers can’t seem to beat the market. Well this is true but in their defense how many mutual funds are allowed to be 100% in cash. I would venture to guess not too many. It is not their job to time the market their job is to pick the stocks that will perform best relative to the market. However if the market goes down it will tend to take most stocks with it. Lets not forget the fees associated with investing in mutual funds. From the starting gate mutual funds start out in the whole relative to the overall stock market.

Market Timing is voodoo. I get a kick out of the fact that just because someone wins a noble prize in economics, their theories become widely accepted. Then everyone using that noble prize theory somehow thinks they are smarter than the market. Maybe people feel better if they lose money investing along side a bunch of PhD’s. I for one do not think I am smarter than the market but I will let the market show me the path of least resistance. If and when market timing becomes widely accepted the market will probably be a very different animal.

I am sure there might be something I missed here but I hope you get my point. There are times when the risks associated with being in the market are out weighed by any short-term benefits of being in the market. I think this is one of those times. State budgets across the country are bleeding red. They will have to raise taxes or layoff state workers, neither of which will stimulate the economy. I could see the writing on the wall when the housing market collapsed where I live. I can’t for the life of me understand how so many economist and market analyst couldn’t see this coming. Then they were in a state of denial for the first six months of the downturn. Please don’t expect them to know when this will end either. I don’t claim to know when it will end, but I will say I don’t think it is over yet.

Stock Market Timing vs Buy and Hold

There is a lot of talk these days about what makes more sense, a buy and hold investment strategy or stock market timing strategy?

Considering the stock market performance over the past ten years, I think the discussion is perfectly reasonable. How smart is it to buy something and forget about it. Is it reasonable to think we can predict what the market, a industry, or a business will look like in ten or twenty years. I think most people, when pressed to really think about it, would realize the absurdity of trying to predict what will happen to a stock in ten years. If you don’t believe me ask anyone who was holding Enron, Worldcom, Fannie Mae, GM, Citigroup or even GE long term.

Wikipedia defines market timing as “the strategy of making buy or sell decisions of financial assets (often stocks) by attempting to predict future market price movements. The prediction may be based on an outlook of market or economic conditions resulting from technical or fundamental analysis.” One of the primary differences between buy and hold and a market timing strategy is the time frame we are trying to predict. A buy and hold strategy by its definition has a much longer time frame than a market timing strategy typically would. A market timing strategy, makes its buy and sell decisions based on changes in the underlying technical indicators or the fundamentals of the market. The time frame of a market timing call based on technical analysis would rarely try to predict what the market is going to do much more than a year out. The farther out we try to predict, the less reliable the prediction. For example it would be relatively easy to predict that a team that makes the NBA finals one year would make the playoff the following year. If you tried to predict who would make the playoffs in ten years, your prediction would probably not be as reliable.

I believe that trying to call the tops and bottoms in the stock market is something best left to day traders and Wall Street professionals. So what about the rest of us? Those of us that would like to retire comfortably without being exposed to market gyrations we have witnessed in the last year. In upcoming post I will be introducing you to market timing models that will help you get better risk adjusted returns than a buy and hold strategy. I hope to do this in a fashion that will not require you to be glued to the markets every move. Most people do not have the time or the inclination to watch the market on a daily basis. That is where I plan to fill the gap by letting you live your life while I keep you updated on changes in the market that require your attention.

Even though I do not try to predict market tops and bottoms, I find myself placed in the realm of market timers. What I do try to do is find times when the risk of being in the market is high and reducing my exposure or tightening my stops. I also look for times when based on historical precedent risk is low and exposure to the market should be increased. I do not want to fight the trend or predict a change in trend. So it is with a certain amount of discomfort that I will sometimes refer to myself as a market timer.