The Investment Scientist

Posts Tagged ‘market timing

Rebalancing your portfolio

Rebalancing your portfolio

Recently, I visited a prospective client in New Jersey. He is currently a client with Fisher Investments, and his advisor told him never to rebalance since that involves market timing.

I have to hand it to this financial advisor for recognizing that market timing is an unproductive endeavor, but he is so wrong about rebalancing that I am compelled to write this article.

Rebalancing is not a market timing activity, it is calendar-driven or condition-driven. For instance, you may decide that you will rebalance your portfolio on January 1st of each year or whenever an asset class allocation is off by 20%.

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Like Odysseus, automatic investments help investors avoid the Siren call of market timing

We call it stupid if someone takes a $55k job, even if he is offered the same job at $100k.

We call it market-timing when the same thing happens in the stock market. The long-term average annual market return is 10%, but the long-term average annual investor return is only about 5.5%. This is documented both by Dalbar’s study titled “Quantitative Analysis of Investor Behavior” and Morningstar’s research on fund returns and investor returns.

How could this possibly happen?

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New year resolution

Tom making his new year resolution

[Guest Post by Tom Warburton] How’s this for a New Year’s Resolution – repeat after me – I Resolve That I Will Abandon Personal Stock Picking And I Will Not Permit That Foolishness To Be Foisted Upon Me By Stock Brokers, Money Managers Or Financial Advisors.

New evidence shows up every day suggesting that it makes more sense to invest in index funds than to personally pick stocks, invest in hedge funds, invest in actively managed mutual funds or let a money manager pick stocks for you.

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Like to hurt yourself?

Investors don’t need outside help to hurt themselves. I’ve been writing about how ignoring conflict of interest, hidden fees, and not taking the necessary time to do due diligence costs investors a great deal of money. Today, I’m going to show you another way they self-inflict pain, and what to do about it.

Let’s imagine you’re in your car. Your vehicle is traveling at 60 mph. How can you, as a passenger, only be going 30 mph? You can’t. It’s an impossibility. Nevertheless, it happens in the financial world all the time.

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“Successful investing,” in the words of British economist John Maynard Keynes, “is anticipating the anticipations of others.” In this vein, a market hits bottom when most people think that most other people think it has hit bottom. Only then, most people start to buy stocks, creating a self-fulfilling prophecy. If most people think the market should hit bottom, but they also think that most other people don’t think that, they won’t buy stocks and the market will continue to drop. So, predicting when a market will hit bottom is a mind game on a grand scale. If there are people who are good at that, I am certainly not one of them.

Prescience not needed, discipline required

Now let me ride a time machine to January 1929. Let’s say I committed to invest $100 every month in the S&P 500 index. I did not have the prescience to know that the market would crash in October and the Great Depression would follow. But if I had the discipline to carry out that investment plan over 30 years, the table below summarizes what would have happened to my investment through the worst stock market period in history.

Year from Jan 1929 Total invested Portfolio value Total dividend received Total gain (loss) Dividend contribution to the gain
1st year 1,300 1,115 23 (161)
2nd year 2,500 1,779 98 (623)
3rd year 3,700 1,737 230 (1,734)
4th year 4,900 2,771 415 (1,714)
5th year 6,100 5,547 629 76 100%
10th year 12,100 12,835 3,024 3,759 80.4%
20th year 24,100 30,786 13,683 20,369 67.2%
30th year 36,100 135,992 47,960 147,852 32.4%

Data source: Professor Robert Shiller’s website

The total gain from my investment plan is the portfolio value plus total dividends received minus total money invested. As you can see, though I suffered losses in the first four years, I had a small gain in the fifth year (January 1934)! This result is not bad, considering that between1929 and 1934 were the worst years for the stock market (an 89% drop) in history.

For the first 10 years of my hypothetical investment, dividends accounted for 80.4% of the total investment gain. This means that if I had invested in high dividend stocks, I would have done even better. (Also see my newsletter article, “Dividends to the rescue in a Great Depression“.)

Here is the take-home lesson from my time travel experiment: to recover from the market crash and to survive a recession, however deep, you don’t need prophecy, just discipline and patience.

The author is president of MZ Capital, a RIA serving DC/MD/VA. Get his monthly newsletter in your mailbox or get to the directory of his past articles.


Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC.


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