As always, if you have not endured Part 1 yet, you really should read it first or none of this will make any sense (I am not guaranteeing that it will make much more sense even if you do read Part 1 but at least you might have a fighting chance) and you can find Part 1 here:
In Part 1 I outlined why “You can’t time the Markets” comes about, but what are its flaws?
Depends on what you Measure
Whenever you see the “You can’t time the Market” line trotted out, it’s highly likely that along with it or very soon afterwards, you will see some Academic ‘Research’ by ‘Experts’ or perhaps just some sort of Research Outfit in the Financial Services Sector which has been employed by a Fund Management Group to “Prove by statistical facts that it is impossible to time the Markets” – so of course they do exactly this because they are being paid to do just that. I will start believing that the World is flat if you pay me enough to think that way and if you pay me a load more I will even write you a detailed Report explaining precisely why the World is billiard table flat !!
Of course such ‘Research’ has in-built biases and because it is based on Hindsight it is pretty much irrelevant and useless. Such Academic appearing stuff takes zero account of what happens in the Real World with regards to your own Personal Risk Tolerance, your time of life, your Goals in Life in general, your day-to-day Spending needs or various other factors that are specific to your situation such as the time available due to Family commitments etc., and of course pure statistical models can never replicate and allow for these aspects. To not do so means that the Research has almost zero value. It also takes no notice of the many psychological factors that affect us whatever decisions we make.
And the biggest problem of course is regarding the Time Period you use to base your Statistics on. For example, to fulfil the demands of a Paying Customer to produce a Report that proves Markets only ever go up, then a Research Outfit with even a tiny bit of brain power would choose the 10 Year Period from 2009 to the Present Day to prove that Markets keep going up for long periods. Very impressive as we have been in a 10 Year Bull Market – but this is the longest Bull Market in history and is obviously on that basis quite an anomaly.
The last 10 years are unrepresentative and highly unusual. Many People started investing back in 2009/10 and have never known a proper Bear Market – my goodness they will get a shock !! Risk has been forgotten and Complacency is utterly rife – this is a very dangerous combination. There is immense Overconfidence.
To do the same thing, they would not choose a Longer Period like 1999 to 2019 – over that Period if you had bought at the top of the Dotcom Peak (loads of People did and the Fund Management Industry was telling People to “Buy, Buy, Buy”, at the time) then after 20 years of lots of frustration and angst you would have only just got your Money back and turned a small Profit in recent years (although to be fair you would most likely have picked up a lot of Dividends so the Returns would probably not be a complete disaster).
There are loads of other instances like this and whenever you see Research along these lines you must consider the Time Period and ask yourself “What might be incorrect or misleading about this Report’s Findings and the way it was conducted?” Being cynical and untrusting is a Key Skill in this game !!
Personal Risk Tolerance
I hinted at this one just above but I will expand on the concept more here. Each and every one of us have our own Personal Risk Tolerance and some people who are naturally of a gambling persuasion take on High Risk punts and others, like myself, are much more Risk Averse and actively avoid High Risk situations and look for a high degree of Certainty in what we Buy and try to control Risk and keep it low.
Then of course there are even more Risk Averse People who are so extreme that they hardly ever buy anything and when they do they are full of angst and worry and are just as likely to sell up and get out rather than to let the Position run. I guess such People don’t really understand what they are doing and therefore cannot get comfortable with even a small amount of Risk and allied to this they don’t understand and follow simple Risk Management techniques like Portfolio Diversification and buying Boring, ‘Steady-Eddie’ Stocks etc. After trying to learn what they are doing, if they cannot overcome the angst then they are probably best off admitting that this is not the game for them and just parking their Cash in a Bank with the best Interest Rate they can get but keeping within the Government Guarantee Limits.
I hate it when I hear People have given up on the Stockmarket though and I suspect in many cases People are struggling simply because they are buying AIM Cr*p and getting sucked into Garbage as the stuff is ramped up to the Moon by all the usual Promoters. Simply by focusing on Quality Businesses that make Money most People can turn their Performance and their tolerance for Risk around.
Your Personal Risk Tolerance depends very much on your Stage of Life. For example, for myself, I do not work and I haven’t done so for 10 years and the thought of it is bringing me out in a nasty itchy rash as I type !! Whatever else happens to me, perhaps the Number 1 thing in my Life is that I never have to get a Job again – this means that I am highly Risk Averse and am not prepared to take unnecessary chances with my Capital. If this means that by sitting out of the game whilst Markets charge higher is the ‘Price’ I have to pay, then in my book it is an absolute Bargain and I would far rather come back to the Dancefloor when the beautiful Dancing Partners are back out doing a jig than when it is full of the plain ones !!
Someone who is 26 Years old and has countless years ahead of them to compound Returns and to build their Wealth and also has a good Income from a Job to fall back on, can take considerably more Risk than I can (or perhaps more accurately, more Risk than I want to take on). When you are close to Retirement and you are going to need your Pot in order to Drawdown an Income for your day-to-day Living Expenses and for Holidays and new Cars and suchlike, you simply cannot take as much Risk as you did when you were a mere whipper-snapper (whatever one of them is !!). Well, you could take on similar Risk but I suspect it would all end badly and you would find yourself collecting Trolleys in Tesco Car Park at 83 years old – good luck to you with that.
Quite simply there is a big difference between the amount of Risk you can take on when you are young and in the ‘Accumulation’ Phase of your Investing Activities from when you are ancient and in the ‘Drawdown’ Phase. And this Risk Level and Tolerance is likely to reduce over the years. When you are 20 you can probably do loads of gambles on AIM Stocks but once you have some more serious Money you will probably graduate in your 30s and 40s to buying Quality Smallcaps and then as you get to 50 and beyond your focus might move more to lower Risk Investments (perhaps even some Bonds) and possibly to more of an Income Portfolio approach. And you’ll probably realise that being down the Pub with your mates is a far better use of your time than looking at a Screen all day (remember what Warren Buff says about each day of your life getting marginally more valuable – it is such an important concept and the older we get the fewer days we have left on the planet so we must use them wisely and be enjoying our increasingly valuable time).
Your Personal Risk Tolerance may also be impacted by events you experience during your Investing ‘Career’. For example, you might do really well in your 20s buying AIM Junk and churning it over but then as you get older you might find that you get into a higher level Managerial Job and you might have a Family and suchlike and you simply can’t focus so much time on your AIM Stocks. If you do not realise these limitations, it is very possible that you try to continue what you were doing before but it all starts going horribly wrong and you might get whacked with one or two utter stinkers. This might then force you into deciding that you need to dial down the Risk Level and the Activity Level and to take a much more lower Risk approach.
However, for all of us our True Risk Tolerance is a lot lower than we think it is. When things are good and we are in a Bull Market, especially if you have only started Investing since 2009/2010, you would probably describe yourself as a Medium Risk Investor. Then we get one of the Market’s periodic and inevitable big Crashes and at that point you might ‘learn’ that you are actually a Low Risk Investor !!! Before the event, we also think we can stand more pain in terms of Market Drawdowns than we actually can in practice when it happens. I am sure Daniel Kahneman has done some psychology stuff around this.
This point is really important. If is fine to go along with the Fund Manager proclamations that you must stay fully invested, but when it comes to the crunch and the Markets are crashing around you, you will most likely find that you don’t actually find ‘staying fully invested’ very pleasant and you will be kicking yourself for not selling a chunk of your holding or Hedging prior to the drop. The vast majority of big falls are highly predictable in advance.
Leaving an Assessment of your Personal Risk Tolerance to a Fund Manager with a simplistic ‘Low/Medium/High’ categorisation is probably a mistake. Likewise if you consult an Independent Financial Adviser you need to be extremely careful that your Personal Risk Tolerance is being realistically measured and you should err on the side of caution.
Once you have figured out your Personal Risk Tolerance and other factors such as your time available to actually do Research and to Trade etc., you need to make sure the Stocks you have in your Portfolio are appropriate to that Risk Level. If you want Lower Risk you need to hold Quality, Defensive, Larger Stocks and probably taking an Income Approach where Dividends are an important element will be the safest way. Equally, if you are going for a Funds approach then you need Equity Income Funds and to avoid High Risk stuff like Sector-specific Funds such as Technology Funds and Biotech and suchlike. Such holdings will make your overall Portfolio more ‘stable’ and reduce the size of Big Drawdowns in the Bad Times. It is important to realise though that very few Stocks are really ‘Defensive’ – it simply means certain types of Stocks such as Tobacco and Water Companies just fall a lot less when things get ugly.
Everybody ‘Times the Market’
I have no doubt that there are a huge number of People who say “You cannot time the Market” who in practice actually are timing it. Of course much of this is prone to the psychological biases of the Individual, but for example if a Person decides to go on Holiday and they decide that they will fund part of the trip from their Share Portfolio, then they Sell some Shares to free up Cash in order to take it out for the trip. Doing this is exactly a form of Market Timing – it might not be in the same sense as thinking the S&P500 is going to drop very soon or rise very soon, but it is a Selling Decision that will be partly based around “Oh, this seems a good time to Sell”.
In a similar way, when someone gets older and they head towards their Drawdown Phase for Retirement, they start to move some of their Money from being invested in High Risk Shares perhaps to more lower Risk Investments. This again is a form of Market timing because you are saying “I want to get my Pot ready for Retirement and Stocks have run up a lot lately so it seems like a good time to be selling some and moving the Cash to one side”……..
When we Buy a Stock we are also ‘Timing the Market’. OK, there may be some right Numpties out there who just complete their Research into the Fundamentals of a Business and then the second they have done this, they head off to their Online Share Dealing Account and they place their Buy Order. God that is daft. I constantly see People criticising Technical Analysis/Charting but what even the most ardent Fundamentals Investor does is to actually look at a Chart and wait for a Pullback or whatever signal they use to help them ‘Time the Market”……..
In truth, we are all Chartists but it is a matter of degree……
To ignore simple Technical Analysis techniques and to disregard simple ‘Trader Tricks’ like Buying on Breakouts and Averaging Up etc. is very silly in my view. These kinds of things work and they are there to exploit. In a similar way when you sell a Stock you should be ‘Selling into Strength’ and selling or Topslicing on Peaks, not when the Market has fallen back as you will mostly be too late and you sell just as the Market is about to turn up again – this is where Candlestick Charting and understanding RSI Indicators (Relative Strength Indicators) and Bollinger Bands can really help. This is not difficult stuff and if you read my Weekend Markets Blogs every week then it is easy to get a handle on some simple methods that I use over and over again. A Chart package like SharePad (to be fair this is arguably more of a Fundamentals package) is ideal for such simple TA stuff and you can even do it on the Chart offerings from many FREE Websites like ADVFN.com (if you look on the ‘Useful Links’ page on my Sites you should find some decent FREE Charting Websites).
Big Nasty Events
At the time I am first writing this piece of text it is the 1st of August 2019 and we are now pretty much 3 Months away from Exiting the European Union. This is clearly something that is fraught with potential for all kinds of strife from Political to Economic to Social and such outcomes are most likely to be something that Markets will be very fearful of and likely to scare away potential Buyers of Stocks and to encourage Sellers to get out. A Nasty combination.
Such Events come along from time to time and are utterly predictable 90% of the time. Just sitting there and letting them happen whilst the Market Steamroller makes you into a 2D replica seems completely insane to me. I know lots of highly experienced and talented Investors and I would say nearly every single one has been increasing their Cash Positions recently and it is obvious why they are doing so. It is just crazy to go into this Fully Invested. I myself Hedge because I see it as beneficial and it stops me destroying my Portfolio I have worked hard to build but the effect is similar in that it lowers my overall exposure to Market Downside Risk.
In my view it is far better to anticipate problems ahead of them happening than to sit there like the Bunny in the Headlights as the Cars rush towards you and then, when it is too late and the Markets have already lost loads of Value, you suddenly panic and decide that you can’t cope with seeing your Stocks getting battered every day and you Sell loads of them at the bottom. Madness that is and ties in with my comments earlier that our Personal Risk Tolerance is a lot lower when the Sh*t hits the Spinny thing with Vanes on it than we think it is ahead of the poop flying.
A rather obvious example is from the Dotcom Boom in 1999/2000 when just sitting there and ‘staying fully invested’ and even worse ‘Buying the Dips’ would have utterly massacred you. I was a very new Investor at that time and even I had the good sense to sell a few things and take a hit on some Positions to move into Cash. People who did nothing got smashed and yet the Fund Management Industry and all the ‘Experts’ were saying we should be buying. Loads of People bought well in the late 90s and then got amazing Paper Profits only to give most of it back in the Crash – utterly nuts unless you are new to the game and that is the only acceptable excuse.
Staying fully Invested in an Over-hot and Overvalued Market strikes me as just plain silly – at least Topslice and bank some Profits and move part of your Portfolio into Cash. I would say the US Tech Market (Nasdaq) is very much like this at the moment and I reduced my Positions in late 2018. Most people would probably do this on individual Stocks but it strikes me that often the same people will stay in an Over-hot Market even when it has clearly run up way too far.
Certain events like the impending Brexit Fiasco and the Credit Scrunch in 2008/9 are Extremely High Risk and with the case of Brexit in 2019 people who were buying at the end of 2018 and early 2019 have done really well. But how much of this is down to their individual skill and how much is simply Luck? The Markets had got quite beat up in late 2018 and many people just charged in and blindly bought because “You should Buy the Dip” and with hindsight that has worked out very well. However, things could have been very different and I suspect a lot of people would have had a big shock if Markets had rallied a bit and then dropped down again as Brexit came into view. I just cannot see any sense in just blindly buying because “The Market always rises” (it doesn’t).
With my own personal Risk Tolerance and Strategy I would far rather sit out of the Market when Tough Times are blindingly obvious and then return in a big way when things are better and I can ‘Put the hammer down’ and make Money ‘When the Sun Shines’ (I’m not keen on making Hay although it might brighten up some Super Food Muesli).
I took the view at the start of the Year that 2019 would be messy and this was particularly the case because the UK was at that point due to leave the EU on the 31st March. Being cautious I intended to Hedge my Long Portfolio of Stocks by about 30% to 40% so I would still be biased to the upside, Sadly in practice my Hedging has worked up much higher than I would have liked but that’s how it has played out and I am having to manage the Positions although I am very happy to be Heavily Hedged with the upcoming potential for mess as the UK could easily leave on a ‘No Deal’ basis. In addition we are approaching September and that is notoriously difficult even without Brexit and the Economic problems which seem to be increasing around the globe.
In simple terms we have to fully accept that the Future is unknowable and we need to think in terms of Probabilities – What is the most likely Outcome and how likely is it? We then Position our Portfolios in accordance with this assessment of likely Outcomes. For example, as we head rapidly towards a messy Brexit, the weight of Probabilities suggests that Markets will take a hit and it is wise to position ready for this and in particular to lower our Downside Risk.
Of course the Academic Models and Fund Managers take no notice of your Personal Risk Tolerance when things get very ugly and they won’t be holding your hand and buying you a pint to console you – the fact is you are on your own pal and Fund Managers couldn’t give a monkeys about you and your emotional wellbeing. Only you can take care of yourself – you must take responsibility and think strategically and think ahead of the pack.
OK, timing the Markets is very difficult and you will fail to do it perfectly a lot of the time but that doesn’t mean it is foolish to try and you should just automatically stay fully invested. Even if you just delay buying some stuff and/or just Sell 10% of your Portfolio or Hedge around 10% because you see serious trouble on the near horizon, it is probably better to do this and be prepared than to blindly stay fully committed and then find that things crash and you cannot sleep and you are panicking and making more stupid decisions. It is sensible and strategic Risk Management if nothing else.
Take care out there !!
This one is all about Hedging:
Here’s the Bear Market Blog which tends to get quite a few outings !!
Here’s the Spreadbet Blog Series – this is the Final Part and there are links at the bottom to the earlier bits:
This ‘Moving into Drawdown’ one is so recent it is still warm:
Here’s a fairly recent one on Overconfidence and other stuff:
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