Is There a Right Time to Invest?
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One
year ago, banks were on the edge of a Great Depression-like collapse. Just six
months ago, millions of would-be investors were reluctant to move into stocks
because the market was falling too fast. Now many are wary because the
market is rising too fast. In the
meantime, investors that maintained a long-term strategic asset allocation and
periodically rebalanced their portfolio have not done badly considering the
magnitude of the economic turmoil.
The Rewards of Asset Class Diversification
The
rewards of asset class diversification can be found in the public performance
of a two mutual funds that act like a disciplined investor with continual
exposure to different asset classes, the Dimensional Funds Advisors (DFA)
Global 60/40 mutual fund (Ticker: DGSIX) and the DFA Global 25/75 (Ticker:
DGTSX). Both funds own the same 11,000+
global stocks, and bonds. Both funds are
passively managed with no high-priced fund manager attempting to guess the
direction of the economy and predict the big winners and losers. Both funds are regularly rebalanced to
maintain the target allocation of the two asset classes. The only difference in
the two funds is the percentage of exposure to the two asset classes, stocks and
bonds.
So
how did they perform over the last 12 months ending 9/30/2009?
The DFA Global 60/40 has a 60% exposure to global stocks and a 40%
exposure to global bonds. According to
Fasttrack mutual fund database, the 60/40 fund was UP 5.19% over the past
year. The 25/75 fund which is only 25%
exposed to stocks was UP 7.60%. During
the same time, the S&P 500 index was DOWN 9.37%. Conclusion: Diversification of asset
classes, owning stocks and bonds, helps manage risk and spares investors from
the madness of worrying about the right time to invest.
Your Brain is Working Against You when you try to time the stock market
In
retrospect, it would have been sheer genius to get out of the stock market
completely in October 2007 and move into cash and government bonds, and then
reverse course again in early March 2009. Behavioral finance teaches that your
brain is working against these timing decisions. The prospect of a financial loss is processed
in the same area of the brain that is trained to respond to mortal danger.
Typically, emotion overwhelms reason causing your sell strategy to be premature
or tardy. The "sell decision" removes the threat of mortal danger, but you now
own a second decision, "when to buy again."
How Could I have been so Stupid?
Next
your brain kicks into hindsight bias as you ask yourself, How could I
have been so stupid? leading you to believe "in hindsight" that past events were
easy to predict. Therefore, future
events should also be just as easy to predict providing reassurance that you
will "know" when to "buy again".
Next Regret
Now
regret avoidance takes over your brain. People tend to feel regret more
strongly when it results from things they did do than from things
they did not do. This creates a paralysis to act in a timely
fashion. For example, it feels much more
painful to have bought stocks in August 2008 and see the price go down than it
is to have neglected to buy stocks in March and watch the price go up. Regret
avoidance is a virtual guarantee that you will miss "the bottom" and re-enter
the market long after the "easy money" has been made.
The Conclusion
Behaviorial biases
work against making timely investments decisions. When your investment decisions are guided by your
behavior and not the market's behavior, your money will not grow as fast. According to Dalbar Inc., over the last 20
years, investor behavior produced an average stock return of 1.87%
underperforming the S&P 500 by a factor of 6.87% per year and falling
behind inflation by 1.02% per year.
Forget
about what you cannot control: picking winning stocks, picking superior
managers, timing the markets. Focus on what you can control: reduce expenses,
diversify asset classes, minimize taxes, stick with an investment discipline. Now
is always the right time to invest.
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