Every time the stock market experiences some extra volatility like the recent few weeks, the debate over market timing reignites. Market timing implies the ability to predict the future movements of the market and the ability to react before markets go up or down. Naturally, when markets go down, investors wonder if it was possible to get out or react before it actually happened.
At the other end of the spectrum, the buy and hold camp believes that because it is impossible to predict the future movement of markets, you must hang on to investments through the ups and downs because over time, good investments and markets will go up.
Most financial advisors will preach the merits of long term investing because that is what they are taught. Some critics have suggest that financial advisors take on the buy and hold strategy simply because it is the easiest strategy to manage money. Buy now and hold on to it forever! Many investors typically expect that professionals should know more than the average person so they should be able to have some insights on trends and patterns of the markets. They also believe that advisors should be actively managing their portfolio in exchange for the fees they make. This creates one of the many disconnects in the investment world where investors may want something the advisors and professionals can't always deliver.
No such thing as perfection
If there were such thing as perfection, we would not have this eternal debate over which money management strategy is better! In fact, if perfection existed, we would have only one investment to choose from and everybody would own it! There would be no need for advisors, columnists, mutual fund companies, and Crazy Jim Cramer on TV.
Unfortunately (or fortunately) this Utopia does not exist. When it comes to investing, I believe in the three “P's”: There is no such thing as PERFECTION. Rather, investing is the ability to increase your PROBABILITY of being right more often than wrong through a disciplined PROCESS.
What is the probability that “buy and hold” works? According to George Hartman, author of Risk is Still a Four Letter Word, if we go back and take a look at the markets over the past 50 years, markets rise 70% of the time and drop 30% of the time. Bull markets also last 3 times longer than bear markets and the gains are usually 4 times greater than the average bear market.
Market Timers now have the benchmark to work with. You must make the right decisions at least 70% of the time to outpace a buy and hold investor. These fats solidify why buy and hold seems to be the better strategy. Keep in mind that this analysis ignores other important issues like the cost to buy and sell regularly and taxation of non-RRSP investments.
Remember that both ‘Market Timing' and ‘Buy and Hold' are simply different processes adopted by different investors. If a market timer is able to be right more than 70% of the time, who can argue against the results. The best money managers in the world are disciplined – some are more active in market timing, others preach buy and hold and there are even hybrids of these two opposing strategies. Different strategies work at different times in different environments. Every money manager, financial advisor or investor should have a process that they passionately adhere to.
Remember nothing works all the time and even great investments, great money managers, and great advisors will make mistakes from time to time. Just make sure mistakes don't outweigh the successes.