There are many reasons to be concerned about the market these days. Among them are the government shutdown, the recent run-up of the market and the fear that stocks are currently overvalued.
There are only three possible answers to the query about whether the market is likely to crash:
Many brokers and advisors will give a variation of numbers one and two. The only accurate answer is number three.
It’s appealing to try to change your asset allocation based on the latest financial news, but you should avoid the temptation. Vanguard nicely summarized the data showing the likelihood of market timing strategies as “remote” in an excellent white paper.
According to Vanguard, “the average professional investor has persistently demonstrated an inability to time the market.” Vanguard cited two seminal studies. One showed meaningful market-timing ability in only one of 57 mutual funds. Another found evidence of market-timing skill in only three out of 116 mutual funds studied. They also referenced additional studies showing investment newsletters, pension funds, investment clubs and professional market-timers “failed to demonstrate consistent success with market-timing strategies." If the professionals have this dismal of a record, how do you like the chances of you and your broker?
The problems of trying to time the market are many. Short-term movements are random and unpredictable. Prices change rapidly, making it difficult to predict them with any certainty. Missing a relatively few of the best trading days by “sitting on the sidelines” can have a seriously adverse impact on your returns.
If uncertainty in the markets is keeping you up at night, there’s a better alternative to market timing. Reduce your allocation to stocks and increase your allocation to high-quality, short-term fixed income bonds like Treasury bills. Your expected returns will be reduced, but so will the volatility of your portfolio. You will be able to more comfortably withstand another market crash.
Unlike other activities, investors who “do nothing” are often rewarded for their patience. Your ability to follow this advice may depend more on your emotions than on a rational analysis of how markets work.
Here’s sound advice from Jonathan Clements, a highly respected former financial journalist at “The Wall Street Journal”: "What to do when the market goes down? Read the opinions of the investment gurus who are quoted in the WSJ. And, as you read, laugh. We all know that the pundits can't predict short-term market movements. Yet there they are, desperately trying to sound intelligent when they really haven't got a clue.”
Dan Solin is the director of investor advocacy for the BAM Alliance and a wealth advisor with Buckingham Asset Management. He is a New York Times best-selling author of the Smartest series of books. His next book, The Smartest Sales Book You’ll Ever Read, will be published March 3, 2014.
The views of the author are his alone and may not represent the views of his affiliated firms. Any data, information and content on this blog is for information purposes only and should not be construed as an offer of advisory services.