Posted February 15, 2016
Marc Rittersporn | Marc@integritt.com
You can admit it: the market has you rattled. You have a written financial plan and a well-diversified portfolio, which puts you on firm ground. And yet, you still have feelings of fear, and most investors are feeling the same way. If you think bailing on the market will help you, stop and think about what the real results of that may be. If you think market timing will solve your problems, think again.
Investors that are trying to time the lows and highs of the market almost always hurt their portfolio performance over time. For example an investor that had a loss over the 1973 and 1974 market decline of 19 to 23% who sold or panicked would have missed out on the recovery of 1975 and 1976 of 28 to 41% respectively (Murray, Goldie, The Investment Answer, 2011).
The biggest issue with trying to time the market is you have to be correct not just once but twice: selling at the market high and timing to buy at the market low.
To say the least, you would have to be able to accurately predict all of the causes and effects on the market in order to be able to time it. And let’s face it, predictability of the market is about as unpredictable as the weather, natural disasters, or the outcome of a presidential election. So why are we so interested in market timing? The answer: it’s part of our behavior as humans.
What of our behavioral predispositions do the most damage to our financial health?
The first behavior that leads to poor investment decisions is fear of losses. The fear of loss has twice the behavioral impact of financial gains. These fears can prevent us from taking healthy risks that we need to take, or in some cases stand and wait when we want to panic and take action.
The second behavior that can cause trouble with investment decisions is overconfidence. The average investor believes that they are above average and therefore they trade more than they should and do not diversify as they should. Research shows that the more people trade, the lower their returns become. Thinking that we can time the market perfectly on the up ticks and down swings to make the greatest profit would make us one of many in a long history of market investors to do so.
Knowing the truth about making investments using market timing is still not enough for many of us to modify our behaviors and choices. We know processed foods are bad for us, but we crave them and eat them anyway. Why? We have self-control issues that most of us do not want to face. We can, however, recognize them and take steps to overcome them by surrounding ourselves with less of what is not good for us and more of what is.
Financial advisors that very much understand the behavioral situations we find ourselves in can get to know their clients and create a financial plan that will address their particular needs. Thereby assisting them with their feelings that can cause them to make market mistakes in difficult and alarming market times.
This is the value of a good financial advisor. They help us plan and stay true to rational economic decisions.
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