One of the biggest downfalls of the common investor is to try to time the stock market. Typically, this correlates with market price and a bias surrounding previous bear market declines. For instance, at this present moment, while the Dow approaches historic highs of 20,000, most assume that market participation is at all time highs as well. It’s common sense to assume that in order for a market to reach new heights, everyone must be in. Ironically this couldn’t be further from the truth. At this very moment 3 of the top 10 largest mutual funds are money market accounts. Simply stated, while the market is reaching these heights, there is also a historic level of cash on the sidelines. It is for this reason, that frequently, I have said that this remains the most hated bull market in stock history. Folks just don’t believe it is happening and refuse to participate.
Now since you’re probably guessing this is evolving into a piece that will trumpet stocks and encourage you to jump in, let me touch on this a bit more. My stance is quite to the contrary. While a majority of folks have yet to fully participate with the bull market run, they have been sitting on the sidelines for very good reason. It was just a few years ago that the market cratered by 50%. Real estate prices in many areas lead the decline as individuals saw not only their retirement savings erode but their home prices as well. Rather than a tangible economic improvement, it doesn’t take a rocket scientist to see that stock prices found their footing due to an unprecedented monetary policy that simply shifted the liabilities from financial institutions to taxpayers. Most investors found it impossible to buy-in to all the financial engineering over the past few years.
In addition to bear market memories and Fed activities, investors have to grapple with thoughts of our national debt approaching 20 trillion, a divided country and a new administration. It is no wonder that most investors have given up on stocks and, despite negative real interest rates once you factor in inflation, will opt for the safety of cash. I believe there’s another option.
Before exploring this, we first must embrace the idea that anything is possible. While it is easy to simply state the market is ‘high’ and therefore must come ‘down.’ I’ve been hearing this same argument for the last 7,000 Dow points. In 2013, when the stock market was approaching 13,000 and had recovered its entire bear market loss, many participants stood on the sidelines in disbelief. As Tatro Capital was increasing our stock exposure due to real fundamental changes, many folks who were already planted on the sidelines were now convinced they had missed the run. Fool me once, shame on you, fool me twice, shame on me. Despite the improvement in stocks and the economy, they were not going to budge. We caught a lot of flack for being bullish then. It wasn’t an easy move.
Rather than understanding that the Dow had in fact changed dramatically (see our previous post on the Dow) those who were sidelined started to adopt a rationale that this level was simply too high and that when it returned to a more respectable level such as 10,000 or even 8,000 they would re-invest their capital. In 2013 when the Dow surpassed 14,000 many said that, this was simply ridiculous and wouldn’t – no couldn’t – last. In 2014 the Dow surpassed 15,000 and by the middle of 2015 it had reached 18,000. It was at this point that most investors had given up in disgust.
Likewise it is easy, at this stage of the game, to review the Dow and conclude that at 20,000 it is beyond ridiculous to invest now. The irony, of course, is that while the market as a whole stands at highs, many sectors, stocks and even countries are near lows. In other words, the rising tide has not yet lifted all boats.
Unless someone has ridden the proverbial market roller coaster this entire time, it’s safe to say that most investors who have attempted to time their entries and exits in this market have been significantly out of step. Just when something seems too high, it keeps going. Fear has taken over and says that the moment one invests will be the exact time a reversal sets in.
Rather than remain stuck in this zombie-like place of indecision, investors should simply revisit their allocation and approach the market from a standpoint of risk temperament rather than being ‘all in’ or ‘all out.’
Over the course of my career I have found that emotion can only be effectively removed by assessing factual evidence. To do this, one must objectively review the market and evaluate real possibilities rather than fictitious storylines propagated by a media bent on selling fear.
To proceed with this exercise, ask yourself one simple question; during the next bear market, how much of a decline can you stomach before you get out? I’ll save you some heartache and tell you that if that answer is 0, the market is not for you and you must be comfortable losing money to inflation in a savings account. Many advisors make this seem like a horrific sin when in reality it’s a real investment plan and one that must be adopted if stock investing is not for you. If, however, you can be comfortable with the idea of owning companies like AT&T, Intel, or ExxonMobil, then simply ask yourself how much of an overall decline would be acceptable if the market fell completely out of bed – 5%, 10%, 15% ?
Let’s now assume that you do not utilize stop loss levels, by which you get out as the market declines. I think is nuts not to utilize this strategy, but that’s a discussion for another day. If during a bear market, stocks decline 30%, and you’ve decided that your max pain level is a 10% decline in the overall portfolio, then your max allocation into stocks should be no more than 40%. (40 x .3 = .12) (This takes into account a 2% return on the fixed income allocation which is approximately the 10-year treasury)
While this caps your upside to 30% of the general stock market return, it ensures that your max downside risk is limited to your risk tolerance. In summary, you’re willing to give up some upside return to ensure you have a limited level of loss. This, my friends, is called a rational approach to successful investing.
There are two types of investors at this stage. Those who are not in the market and absolutely paralyzed by fear that the moment they re-enter the bottom will fall out. The other group has been in, making money, and now faces new anxiety over this 20,000 level which seems far too high for gains to keep coming.
For each group I encourage re-visiting your allocation and risk temperament. Compare this to your overall financial goals and determine if you’re approaching the markets rationally or if you’re emotions are getting the best of you. For each group, stop trying to time the market because it is a strategy that does not work and will only result in more frustration.
Allocation is the key to any successful investment plan and one that should be revisited with regularity. If this is something you’ve never done or need to revisit, there is no better time than right now. Let us know if we can be of help.