|Print this article|
Investors often spend a lot of their time in trying to identify when the market is very low or high, and timing the purchase and sale of investments accordingly.
In other words, they want to time their exit when the market has reached its top and to time their entry when the market has reached a bottom. Is this a practical idea?
Warren Buffet, one of the successful investors and the world's third richest person says:
1) Always invest for the long term. Stop trying to predict the direction of the stock market, the economy, interest rates, or elections.
2) Much success can be attributed to inactivity. Most investors cannot resist the temptation to constantly buy and sell. I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen for the next five years. Our favourite holding period is forever.
Well, Buffet is not advocating moving in and moving out of a stock or stock market. His strategy is to buy and hold for the long term.
K Ramalingam, an MBA (Finance) and certified financial planner, is founder & director of Holistic Investment Planners (P) Ltd. He can be reached at firstname.lastname@example.org
Research done by leading financial institutions show how timing affects your investment returns. By frequently moving in and moving out of the market, it is not possible for an investor to capture the overall growth of the stock market.
Also, it is highly not possible to predict the market always. The reason being stock market is not moving in a predictable or regular pattern. But historically the stock market is moving up in the long term.
The studies also reveal that staying away from the market for only a limited period of time will badly limit your investment results. On the contrary, holding your investments in the stock market can considerably increase your returns.
Take any five-year period in the history of stock market, and it is very difficult to find out one in which the market has fallen down.
In reality the market has gas gone up in 87 per cent of the time in all such 5-year periods. If we stayed in the market for any 10-year period, the chances are 98 per cent of the time your investments would have increased. Even though the investors suffered short-term losses during the technology bubble burst in 2000, the long-term investors made substantial returns.
You could have seen a lot of success stories of people, who bought a good stock 10 or 15 years back and accumulated a good amount of wealth now because of the appreciation of those stock prices. But have you ever heard of a person accumulating wealth by timing the market or moving in and moving out of the market?
By timing the market you may make profits in a few transactions, but you will not be able to make profits forever. There is a lot of difference between making profit in a single transaction and being a successful investor forever. So time in the market is much more important than timing the market.
But then why do people not buy and hold stocks for the long term? The research results on human behaviour reveals investors are inclined more towards a sexy idea when compared to a good idea. By trying to time the market to make a fast buck, you're gambling, not investing.
But timing the market is a sexy idea. We think it is a stock market technique and shortcut to get rich quick.
We need to understand the difference between principles and techniques. Principles are very basic and never change. Principles are guidelines. Principles are simple at the same time very authentic.
Techniques, on the other hand, are tools or methods to execute principles. Techniques will enhance the results of the principle. But always remember a technique or tool need to be in line with the basic principles. If we use a technique that overlooks a basic principle, then definitely we will have a very bad hit.
Communication is a powerful technique. Accounting is a good tool. But if we use these techniques and tools as a short cut and not in line with the basic principles, what will happen? We know what happened to Swami Nithyananda and Satyam Computers.
You may seem to succeed, but eventually it is not possible to sustain that success forever.
Similarly investors need to be very careful about investment techniques that are not in line with the investment principles. These techniques are all illusions. They seem to be attractive, flashy, trendy, sexy but not authentic. Though predicting the market, timing the market and moving in and moving out of the market seem to be working it is only an illusion.
People believe that investment experts, mutual fund managers and large stock broking houses will be able to predict and time the market.
But is that the reality?
If there are investment experts who will be able to correctly predict the market they will not be writing or giving interviews about it in the media. They will be silently investing and making money without revealing their secret.
Successful mutual fund houses are not timing the market. They admit that it is practically not possible to do it. That is why they always maintain a fully invested portfolio. They will maintain a very small portion of cash to meet the liquidity requirements. They are not moving in and moving out of the market.
On the other hand, the fund houses, which tried to time the market by sitting on cash, have delivered below average returns during the present recovery from 9,000 to 17,000.
Most of the big names in the stock broking sector were opening more new branches in the upcountry side during the second half of 2007 (when the market was moving closer to 20,000 levels), expecting the market to go up further and hence their businesses will grow. But within six months, market had collapsed.
In the second half of the 2008 these companies decided to wind up their newer branches in the upcountry as they were expecting further downside. But again within next six months market started their recovery.
So, timing the market is really an obscure idea, and investors should not fall prey to it. At the same time, investors can follow profound principles of stock market investing like diversification, investing for the long term, buy and hold, don't panic, have a plan and stick to your plan.
Stock market investing also has got some investment techniques that are in line with the above-mentioned principles. Investors can adopt these techniques such as systematic invest plan, systematic transfer plan and asset allocation.