Is it time to sell when markets hit new highs?
"If you can enjoy Saturdays and Sundays without looking at stock prices, give it a try on weekdays." —Warren Buffett
When was the last time you had a drink at the bar or a dinner gathering with friends and the conversation turned to the stock market?
Everyone loves to share their story about a favourite (or hated) stock. And then there's the inevitable question of which investments are good to buy right now. Perhaps someone has been following the news and wants to know your opinion on the stock market highs we reached just a few days ago. Since markets are so high now, did you ever find yourself wondering if it is only a matter of time before it all comes tumbling down?
Market timing can be extremely alluring. The idea that you could be clever enough to read the signs and get in or out of the market at the right time is a fantasy that tempts even the most disciplined long-term investors. Unfortunately, the reality is that this fantasy rarely comes to pass. Attempts to time the market results in disaster much more often than success, and intelligence or experience has little to do with that outcome.
The good news is that none of that is necessary. If you have worked with an adviser to build a portfolio that can weather both the good and bad times in the market, just let that portfolio do what it was designed to do and help you reach your financial goals while you go about your daily life without too much stress – just like what Warren Buffett suggests.
The truth is that markets are extremely efficient and competitive when it comes to processing information. In 2018 alone, US$463 billion worth of stocks were traded every day – which comes to about US$68 trillion in a year. There are tens of thousands of institutional investors tracking and analysing the market and buying and selling with the aid of cutting-edge computer systems working with split-second accuracy. Any opportunities to beat the market are instantly incorporated and reflected in stock prices every single second the market is open.
An individual investor simply cannot hope to compete based on an investment recommendation they read a few minutes ago, which in all likelihood was written several days ago (due to the time needed to pass the institution's compliance checks). By the time you receive the news, it will have become old news, with institutional traders having already acted on that a long time ago. Using that outdated information to then pick up individual 'hot' stocks or make tactical changes to your investments is probably going to do you more harm than good.
As it is, even professional investors (e.g. fund managers) already have tremendous difficulty beating the market. A study by Dimensional Fund Advisors on actively managed investment funds found that over the past 20 years, 77% of equity funds and 92% of fixed income funds failed to survive and outperform their benchmarks after factoring in costs.
Sounds familiar? How many times have you held a fund, only to have it closed down or combined into a different strategy run by the fund manager? Over time, investors will flee from under-performing funds, making them more costly to run, with the last few investors left bearing the brunt of the costs. The fund manager then shuts down the fund, effectively wiping out their records and performance history.
But let's say that you are very concerned about market prices right now, and decide to sell out your investments in case prices fall. You feel comfortable cashing out and holding cash. However, when do you come back into the market? What would be the right price to reinvest at?
We have written before about the accuracy of market timing calls. Investors who time the market have to make correct calls not just once, but twice: firstly when to buy, and then when to sell. This dramatically changes the odds of success, as Nobel laureate Professor Robert Merton explained in a recent interview with Dimensional:
"Timing markets is the dream of everybody. Suppose I could verify that I'm a 0.700 hitter in calling market turns. That's pretty good; you'd hire me right away. But to be a good market timer, you've got to do it twice. What if the chances of me getting it right were independent each time? They're not. But if they were, that's 0.7 times 0.7. That's less than 50/50. So, market timing is horribly difficult to do."
The evidence is also in favour of continuing to hold stocks through market highs. As Exhibit 1 below shows, new market highs are actually followed by further highs for the majority of the time, with positive returns over the next one, three and five years. Someone who sells at a market high will thus more likely end up suffering a loss when reinvesting in the future.
Outguessing markets is much more difficult than many people might think. Anecdotal evidence, hearsay from friends and advertisements from "sure win" trading courses have all given us the wrong impression of how easy it is to do.
Some people do get it right some of the time, but that is more a matter of luck than skill. There is no evidence that market timing can be done reliably, even by the professionals who study the markets all the time.
The good news is that we don't need to time markets correctly to have a good investment outcome. Over time, markets have provided returns to investors who have taken a long-term perspective and remained disciplined in the face of adverse news and noise.
By ensuring proper asset allocation, diversification, and managing expenses, you too can benefit from what capital markets have to offer.
