After nine years, some investors are getting increasingly worried about the continued viability of the long-running bull market. Add in the rumors of rising interest rates, and some investors are ready to make dramatic changes to their equity investments, such as moving a significant portion of their portfolio to cash or cash equivalents (money market funds or ultra-short bonds).
Changing Your Asset Allocation
Before you let your nerves rule your investment strategy, consider that changing your asset allocation based on nerves is something your financial advisor would probably caution against if you are properly allocated. There are a couple of reasons for this. First, in the investment world, keeping cash in your portfolio is referred to as “cash drag.” This means your portfolio will likely trail market returns because cash does not generate significant returns in comparison to the market over time.
The second reason is when you change your asset allocation based on nerves, you are engaging in “market timing,” which is seldom profitable long term.
Here’s the problem: While the bull market has been running strong for nine years, it’s impossible to correctly determine when that cycle will change. If you decide to move a significant amount of your portfolio to some form of cash, you could miss several more months (even years) of solid equity-market returns. Or, the market could immediately drop right after you sell—then what will you do? Will it be time to move back into equities? All your decisions will depend on correctly reading the future, not just once, but twice.
The Challenges of Timing the Market
That’s the trouble with market timing. To win, you must correctly predict market cycles. First, you must predict when to sell an asset class. Now? Next week? The end of the year? You don’t have a crystal ball, so you can’t possibly know the correct answer.
If you correctly guess when to sell, you’re not free from the market-timing trap. In fact, you’re just halfway there. Now, you must figure out when to get back in. If the market drops 600 points in a day, will you dive back in? Will you wait for a full week of falling returns or a terrible month of returns? What if you wait for a bad month, buy back in and the market continues to fall? Will you bail again?
Even if you are looking like a genius because you successfully timed both sides of the market, did you really make any money? That depends on the size of your gains and the cost of trading in and out of the market. If your gains are relatively modest, trading costs may eat up most of your profits.
We caution against market timing because the large number of unknowns that you must get right, coupled with the costs of making all those moves. Instead, we encourage clients to stay calm and remain focused on long-term investing goals, making portfolio changes based on personal circumstances, not market cycles.
If you now understand the pitfalls of market timing, but you are still nervous about your portfolio, you may have another issue. Your anxiety may be revealing that your risk-tolerance level and your investment strategy are misaligned. In this case, a financial advisor can help you re-evaluate your initial strategy. This would be an example of a personal circumstance that may require a portfolio adjustment to match your investment personality.
A professional financial advisor can help you identify the source of your investment anxiety and, if necessary, help you make adjustments based on your strategic plan — not on arbitrary market cycles.
Craig Birk, CFP®
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