Obsessing about the right time to be in or out of the market is harmful to an investor's long-term prosperity, but is still an important signal that an investor either doesn't have a systematic approach to investing, or is following one that doesn't suit them. Know what can help?
If I have any amount of expertise in investing, it’s only because I have made a lot of mistakes. Probably my biggest bugaboo in my first decade of investing was trying to time the market - trying to guess the right time to buy or sell to get the best price. When I found myself with dollars to invest, I looked at market news, tried to figure out the trends in prices, and tied myself in mental knots as I second-, third-, ninety-second-guessed my choices.
I was all set to write a post on the dangers of market timing and how Risk Parity helps overcome that destructive tendency when I saw that John Williamson of Optimizedportfolio.com just made a video on his YouTube channel assessing the ability of investors to time the market. He says it better than I could have with this superb overview:
Building on that video, I’ll also add that a Risk Parity approach can help keep investors on the right track and avoid the temptation to time the market.
Having specific target allocations in mind helps give investors a more systematic view of their portfolios. No need to wonder if now is the right time to sell stocks or buy bonds - you just look at your current weights and see what is over its target allocation and what is under. You want commodities to be 5% of your portfolio but now it is 8? Want growth stocks to be 15% of your portfolio but now they are 12%? You don’t need to worry about when the “right time” is, you can just follow the numbers.
Justin
The key to Risk Parity is balance, and with a diversified and balanced portfolio, there will always be something in your portfolio doing well and something doing badly. I look at constructing a "decathlete" portfolio - maybe not the best at any one event but prepared to succeed in multiple events. If the investor switches from a mentality of trying to find the perfect thing at any moment in time and instead looks a bit broader, towards what will work throughout the ups and downs, you can eliminate that lingering question of what is the “right” thing to be in. You’re already in it. Stay the course.
If you are getting into a Risk Parity approach and still find the siren call of market timing to be irresistible, then that would seem to be a sign that the asset allocation you have is not quite the right one for you. Perhaps the actual sight of your portfolio dropping is telling you that the risk level you thought you could handle is one that you actually can’t. If that’s the case, then maybe move to a portfolio with lower expected volatility (check out the comparison of my test portfolios here, and look for ones with lower expected standard deviation).
As Williamson notes, the feelings that can overwhelm investors, that they should get out of the market right now!, or quickly move to a different asset class, or whatever, are not helpful for long-term prosperity. At the same time, though, that doesn’t mean the feelings are not important. Really, they are signs that an investor hasn’t yet found the right portfolio for them, and that they haven’t reconciled what it means to take a systematic approach to investing.
Risk Parity can help!
Another great video on market timing, and why it doesn't work, is this from Ben Felix and Common Sense Investing: