Why is Market Timing Necessary for Investing?
There are extended periods of time in the history of the stock market when buy and hold would not work.
For example, if you were planning to retire in 1930 and relied on your investment egg, you would be in for a big surprise. The market crashed and did not reach same level until almost 1954. If you bought at the top of 1929, 24 years would be a long time to buy and hold to break even in nominal prices.
DOW Jones Industrial Average Historic Prices 1929 - 2009 (Log Scale) - Buy and hold at your own peril
The market was flat in nominal prices from 1965 to 1982. But your money invested in 1965 would only have 10% of it’s purchasing power in 1982 due to high inflation. That would be a terrible disaster if you relied on that money for anything serious such as retirement.
Similarly, if you invested in late 1990s, you would be back to square one by the end of 2008 and the US dollars again failed to keep it’s value due to massive credit inflation bubble FED has been fostering.
There are many cycle theories such as Kondratiev Cycle, Elliott Wave Theory that try to explain these bubbles and busts. Understanding why they may happen is a good step so that we may be cautious in our financial decisions.
The Big Picture - Historical Stock Market Returns
Below is a chart that shows the historic returns, adjusted for inflation, for the UK market for the last 200 years. It speaks for itself. It looks like a bell curve which shows the highest probable return for the stock market is -2% to +4%. If your 401k is long heavily in stocks based on common wisdom of this age, you may be betting that the 1 in 15 chance on the very right edge of the graph will happen again.
Source: http://seekingalpha.com/article/146891-triumph-of-the-market-realists#comment-641432
Buy and Hold is Dead
It was never alive. Buy and Hold was the common wisdom based on the bull market of 1980s and 1990s. That generation witnessed the bull market and along with the propaganda of mutual fund industry, they advertised buy and hold after the fact. We all heard the sales pitch:
If you miss the best 10 days of the market for the last 10 years, you will be left with pathetic returns. So it is best to stay invested at all times.
This claim may sound logical at first. But when you think about it, what are the chances that you will pick only 10 days to stay out of the market and those days will be the best days? The probability is probably less than being hit by a lightning.
The truth is if you stay out of the market, you will miss some good days as well as some bad days. The trick is to turn the odds in your favor. If you actually compute it, you will see that if you miss the best 10 days and the worst 10 days, you actually end up with better returns compared to buy and hold, at least in S&P 500 for the last 10, 20 years.
In general, if you have a strategy that allows you to stay in the market when it is more probable to go up, and stay out, or maybe short the market when it is more probable to go down, then you naturally make more money. Of course the mutual fund industry (and your 401k funds) do not want you to know this because they charge fees if you stay invested with them.
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Market Myths Exposed eBook - Now Available
You've no doubt heard the old mantras "stocks for the long haul," "diversify," "buy and hold."
Investment gurus worldwide repeat them daily ad naseum. But are they really wise investment strategies for ALL markets as advertised? Can any piece of advice that's so simple yet so vague be of use to you as an investor?
Anyone who diversified their portfolios across several stocks, bonds and commodities over the past three years knows that diversification is no foolproof way to profit. The same goes for anyone who decided to buy and hold the S&P index 10 years ago -- they're 20% down even after the recent rally. Many individual stocks and commodities have performed much worse.
During the mania, when the trend was almost always up, virtually anything had a good chance to go higher. Investors ignored real safe-investment advice, because there was always someone lucking into a moon shot during the insanity. The S&P index itself – followed by the NASDAQ and other futures markets – sat at the center of the mania, and simply being in an index back then often outperformed other popular strategies. That's all over with now.
Our friends over at Elliott Wave International have just released a brand-new ebook to help you sell and fold bad investment advice for forever. EWI's 33-page Market Myths Exposed eBook takes the 10 most dangerous investment myths head on and exposes the truth about each in a way every investor can understand.
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2009 Stock Market Articles Part 2
2009 Stock Market Articles Part 1
2008 Stock Market Articles
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