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A Crash Overhang

by on April 20, 2010
One of the unfortunate hangovers from the 2008–‘09 market crash has been some investors continuing to try to “time” the market with their mutual funds. We continue to hear that small retail investors, and usually those without an investment advisor, have not completely returned to the stock market. Whether this is with their 401(k) plan or other investment portfolios, some investors have missed much of the recent recovery employing some unproven strategies.

Frankly I can understand their concerns and fears and their desire to be out when the next crash happens. The problem is there’s usually no one who knows exactly when the next correction will happen. Consider this… since March ’09 the stock market has grown back in spite of all the negatives we hear in the news today, while many have warned another correction is coming. Sometimes in the industry we hear this referred to as, “the market climbing a wall of worry.”

Remember that a strategy of “market timing” almost never works to improve one’s overall return when considering a full market cycle (from the peak, to the valley, and back to the peak again), particularly with mutual funds. This can be validated by third-party research and is why you hear most Investment Advisors discourage market timing. However, I must say moving out of the market can be an effective means of reducing fear.

I have found some of the confusion comes for personal investors as they have heard and read investment language (reduce stock exposure, increase cash position, expect a market pullback, stop-loss, limit order, etc.) that typically can be effective when trading individual stocks. Don’t confuse this with investing in mutual funds. According to Vanguard, mutual fund investing provides greater diversification as, “a single mutual fund most likely holds more securities than you could ever buy on your own. An advisor handles the fund’s investment management responsibilities, taking the burden off of you.” Therefore, remember that an actively managed fund manages within its prospectus objective in light of what is happening in the economy.

Also given the logic that investing in individual stocks can be significantly more risky than investing in stock mutual funds, it’s logical to conclude that you can also lose more in individual stocks. This contributes to why we saw many individual stocks decline much greater than stock mutual funds over the recent 2008-’09 market correction. Consider as Investorguide.com explains, “Earning a high level of return requires taking more risk, but taking more risk does not always equate to a higher return. No matter what you invest in there is an inherent level of risk associated with all investments.”

So in the end, unless there becomes a serious market correction, which doesn’t happen very often, mutual funds may not offer enough volatility to pay off using common timing strategies. In other words, mathematically it’s very difficult to make it work. As we have learned in the last correction, a market correction is not a clear signal that another major correction is around the corner.

In summary, there are some strategies that can help worried investors that are concerned of market risks. But quite frankly, and contrary to what you may hear, market timing usually does not improve the overall long-term return. And if you feel advisors are not forth coming about timing, ask your investment advisor if he “times” his or her mutual funds.

From → 2010

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