Why market timing does not work

 

A paper published by a business professor ten years ago made this point emphatically.

The evidence from 15 international equity markets and over 160,000 daily returns indicates that a few outliers have a massive impact on long term performance. On average across all 15 markets, missing the best 10 days resulted in portfolios 50.8% less valuable than a passive investment; and avoiding the worst 10 days resulted in portfolios 150.4% more valuable than a passive investment. Given that 10 days represent less than 0.1% of the days considered in the average market, the odds against successful market timing are staggering.”

The odds of getting out of the market at just the right time and then getting back in at just the right time are roughly the same as winning the lottery.

This points out the reason why creating a portfolio that will allow you to invest for the long term is essential to creating wealth.  You can achieve a decent return and sleep well at night.  But in order to do this your portfolio has to match your personal risk tolerance (your Risk Number), one that differs with different people.

We are in a long-term Bull Market, but Bear Markets follow Bulls as night follows day, and some day the Bear will return.  That’s when having a properly diversified, risk-tolerant portfolio pays off.  Big time.

“Will a Stock Market Drop Affect My Dividend Payments?”

We got this question from a client of ours earlier this week in response to the stock market’s wild market ride.  It is a great question!

The quick and easy answer is “No, it shouldn’t.”  And we could pretty much stop right there.  But if you know us, you know we love to get into the explanation!  So here it goes…

Let’s go back to the very start, with “What is a dividend?”  A dividend is a payment of a portion of a company’s earnings distributed to the company’s shareholders.  Dividends typically are paid in cash, and the company’s board of directors decides the amount distributed.

Now the next question would be, “What causes a company to raise or lower their dividend?”  The answer is cash flow.  It all comes down to earnings and profitability and how much money the company has remaining after paying for all the things that keep it running, such as salaries, research and development, marketing, etc.  After those expenses and the dividend payment, the remaining profits go back into the company.

When a company pays a dividend, their board is essentially deciding that reinvesting all of the company’s profits to achieve further growth will not offer the shareholders as high a return as a dividend distribution.  That said, companies offer a dividend as extra enticement for investors to buy their stock.  Moreover, a steadily increasing dividend payout is an indication of a successful company.

Therefore, it stands to reason that a company’s steady or increasing profitability will typically lead to steady or increasing dividend rates, and a decline in profitability will lead to that company reducing or eliminating their dividends.  Most U.S. companies are loathe to reduce their dividend rates because it signals to investors that their profits are lagging, which results in their stock price getting pummeled.  And that is not a good thing for their company’s board or management.

The final long-winded answer: You will often see companies cut their dividends when there is a severe economic crash, but not in reaction to a market correction.  Since dividends are not a function of stock price, market fluctuations and stock price fluctuations on their own do not affect a company’s dividend payments.

If you have a question, feel free to send it our way!

(Here is an interesting tidbit: the term “dividend” comes from the Latin word dividendum, which means “thing to be divided.”  With a dividend, companies are dividing their profits up among shareholders.)

Successful and investing and emotional control

One of the big benefits of professional money management is “emotional control.”

Emotional control is the ability to control one’s emotions in times of stress. Napoleon once said that “The greatest general is he who makes the fewest mistakes.” There is a similarity between war and successful investing. Both require the ability to keep a cool head at times of high stress.

There is another old saying in the investment world: “Don’t confuse brains with a Bull Market.” When the market is going up, it’s easy to assume that you are making smart investment decisions. But your decisions may have nothing to do with your success; you may simply by riding the crest of a wave.

That’s when people become overconfident.

When the market stops going up, or the next Bear Market begins, the amateur investor allows fear to dominate his thinking. The typical investor tend to sell as the stock market reached its bottom. In fact, following the market bottom in early 2009, even as the stock market began to recover, investors continued to sell stock funds.  Since then the market has doubled.

Professional investors are not immune to emotion, but the good ones have developed investment models that allow them to ride through Bear Markets with moderate losses and ride the rebound up as the market recovers. It is that discipline that allows them to make fewer mistakes and, like Napoleon’s general, come out ahead.

What do you do when the market drops 300 points?

Yesterday scared a lot of people.  And when the July brokerage statements arrive, many people will not want to open them.  It’s not been a good month for stocks.

When there’s a sudden drop in the market, one that makes people take notice, we always wonder what’s going to happen next.  Is it the beginning of a steep decline, perhaps a Bear Market?  Or is an opportunity to buy stocks on sale?  A Blue Light Special?

The answer is: nobody knows.  Anyone who pretends to know is lying.

If you have a properly constructed portfolio, what happens next won’t bother you.

By a properly constructed portfolio we mean a portfolio that’s designed to be robust, that’s properly diversified and one that is designed for your risk tolerance.

When the stock market is going up, the value of that part of your portfolio devoted to stocks increases in value.  And while you may think that’s a good thing, what it’s doing is increasing the portion of your investments to stocks which are the riskiest part of your portfolio.  Over time, during a Bull Market, your portfolio is becoming riskier and riskier.  Unless you take active measures to bring your investments back to your original asset allocation – a fancy way of saying the portion of your portfolio that’s devoted to stocks and bonds – when the market takes a dive, your portfolio will decline more than you want.

If yesterday’s drop felt more like a drop-kick, you own too much stock. It’s time to to re-evaluate your risk tolerance. Talk to your financial advisor.

So, to answer our original question: What do you do when the market drops 300 points?  If you had a portfolio that’s designed with you and your future in mind, the answer is nothing.  On the other hand, if it caused you to panic, call us and let’s talk.