Does anyone know when to get in and out of the market? Many professionals try, and we’ve heard a few theories from amateur investors lately. It’s tricky to tell fact from fiction. There are a million ways to analyze historical data to find timing patterns that appear to produce attractive returns. The real question you need to ask yourself: “Is there any reason why I should expect that pattern to continue in the future, or is it purely due to chance?”
An example. Over the last thirty years, if you sorted stocks based on the letter of the alphabet they started with, you would see that stocks that began with the letter “M” outperformed those that started with the letter “E.” Is there any reason to suspect this to continue over the next 30 years?
No, clearly, the letter of the alphabet should have no impact on a company’s returns. The reason for this difference is that Microsoft was a large, successful company over this period, while Enron was a large, unsuccessful company over this period.
When working with “noisy” data, the odds that the results are evenly distributed is very small. If you roll a die six times, the odds of getting each number exactly once is tiny (1.5%). That means there is a 98.5% chance you will roll some number two or more times and some number zero times.
A typical market timing strategy we hear about around this time of year is to “avoid investing in the month of September.” At first thought, it seems odd that September would produce below-average returns, but when you look at the historical data, it is true!
Is there any economic rationale as to why this should continue in the future? I can’t think of any. Some claim that it is due to market participants selling positions to clean up their books after taking time off in the summer. If that were true, why wouldn’t investors try and get ahead of it and sell in August? Or why wouldn’t hedge funds gobble up all the low-priced stocks and keep prices stable?
Let’s dive deeper into the data and look at the five largest market declines over the last 100 years. Each drop produced several months of negative returns, but all five of them spanned September at some point.
The recession peaked in different months every time, and every month was hit negatively at some point. However, there was bound to be one month affected more than others. It just happened to be September. From 1926 to 2021, 52% of the September months had positive returns. The large negative returns from a few market downturns have skewed the average to be negative. The question is, do we expect this to continue in the future?
Whenever you hear of these market timing strategies, you need to ask yourself if there is a logical economic rationale as to why the trend existed in the past and why it should continue in the future. Is there some risk associated with September we don’t know about? Is there some behavioral rationale that investors can’t arbitrage away? If you can’t come up with a concrete reason, whatever anomaly you are looking at is most likely due to chance and not a reliable trading strategy to implement in the future. Before accepting any investment truism, it is important to be sufficiently skeptical before implementing it yourself.
Returns from Fama/French CRSP Data Library.
Clients and friends of Hill Investment Group will recognize the story behind “The Paradox Of The Herd” written by John Jennings because they are living it every day that they are Taking the Long View. John is the President and Chief Strategist of St. Louis Trust & Family Office, author of the blog Interesting Fact of the Day and forthcoming book titled The Uncertainty Solution: How to Invest with Confidence in the Face of the Unknown, and good friend of our firm.
The brief post discusses the emotional rollercoaster that those who invest differently than “the herd” ride, even though their rational selves know that doing so has a good chance of leading to higher expected long-term returns.
The good news is: You’re not alone. Everyone at Hill Investment Group is riding the same roller coaster as our clients because we invest our money the same way. (N.B. Everyone has their own asset allocation.)
I taught personal finance and leadership at the high school level for over twelve years. One of my favorite concepts I loved to communicate was the magic of compounding. Although great financial value is derived by recognizing the wisdom of compounding, I believe there is even greater value in recognizing the compounding of wisdom.
Could your financial success be exponentially enhanced by making wise financial decisions repeatedly over a long period?
In the months ahead, I’ll share important ideas I’ve seen result in positive financial outcomes, and give you the roadmap. The goal? Help you make wise choices at every turn in your own financial road trip. Think of it as an introductory – or “101” – guide to compounding financial wisdom.
Compounding Wisdom on Investing:
Compound Wisdom Actions
- Pay yourself first – invest every time you get paid, even if the amounts seem small, through automatic transfers to either your 401k/403b or personal accounts.
- Stretch to invest – target 15%-25% of your income to save or invest each year.
- Diversify – spread your investments across multiple asset classes to manage risk.
- Leave nothing on the table – make sure you receive the full match your company offers.
- Look out for Roth – consider the Roth 401(k) option if available in your employer plan.
- Control for fees – you can’t control returns, but you can control investment fees by investing in low-cost funds.
- Keep emotions in check – you invest for the long term, so resist the urge to trade urgently, or time the market.
- Rebalance – keep your investment allocation in balance across asset classes.
- Harvest your losses – take advantage of down markets to accumulate valuable capital losses.
- Be aggressive – as a young adult, don’t fear an allocation that is dominated by equities.
- Look under the covers – many target date funds are costly and may not be appropriately allocated.
- DIY is difficult – work with an advisor who always works in your best interest (also known as a Fiduciary).
Actions to Avoid
- Waiting to get started – your most valuable dollar invested is your first.
- Failing to sign up for employer retirement plan – start the first month you are eligible.
- Failing to earn the entire match – one of the only free lunches around.
- Investing in mutual funds with high fees – don’t be seduced by sexy short-term returns that are unlikely to persist.
- Paying penalties – don’t incur penalties by withdrawing from retirement accounts early.
- Abandoning your plan – don’t get sucked into the latest “can’t miss” stock recommendation you hear online or from a friend.
- Timing the market – invest regularly or whenever you can, as early as you can.
- Loving your company too much – monitor the risk you may incur from owning too much company stock.
Feel free to pass this along if you know someone who might benefit from the guidance and look for more from me in this monthly series.
I lead our Hillfolio level client service and planning efforts, learn more about me here and reach out if I can help you put the magic of compounding on your side.