Most financial advisors will recommend against any attempts to time the market. It can’t be done, they will tell you, and I agree. Timing the market or specifically identifying market tops or bottoms as opportunities to buy or sell is usually a futile effort. What financial advisors fail to tell you, however, is that market awareness is important and should be a factor in your investing decisions and strategies.
Photo by gadl via Flickr
To be aware of the market means to follow the market, even if at a very basic level. This doesn’t mean you need to know the exact level of the Dow or the NASDAQ each day, but it does mean you have a good feel for the current level and trends of the broad stock market. For example, you should be aware that we hit historic lows back in March of 2009 and in the last six months, we have had a fierce rally of over 50%.
Now, a market timer would typically try and identify a top at this point and perhaps sell their positions or maybe even go short against the market or specific positions. This is not the recommended strategy because it is too difficult to identify a market top to make a move this bold. Bold moves require a high level of certainty, and future predictions of broad market direction will rarely have such a high level of certainty.
Most professionals will recommend consistent buying of stocks over a long period of time. This dollar-cost averaging approach will prevent you from being over-exposed to a bad timing of purchases. Many will even recommend blindly continuing this approach no matter what the stock market has done or is currently doing. I disagree with this approach.
Going back to our current example, I would recommend using market awareness to adjust an investor’s buying activities. In a market that is up 50% in six months, I would not want to buy as much as I have been buying as the market has gone up over the last several months; therefore, I would cut my buying activities in half at current levels. If the market continues to go up, then you’ll continue to do well. If the market corrects and moves lower, you’ll be well positioned to buy larger “chunks” at lower, more attractive prices.
Remember, you want to buy low and sell high. Most people tend to buy high and attempt to sell higher, but in many cases, this doesn’t work. Since you’re probably focused on the long term, selling is not really on your mind, but this doesn’t mean you shouldn’t attempt to maximize lower prices and minimize your purchases at high levels.
Remember, a financial advisor is the professional or the expert in your relationship; therefore, they want to be the ones making strategic decisions. Furthermore, if you slow your buying when the stock market is high, you will be accumulating cash. Financial advisors typically don’t make money on idle cash. They want you to be fully invested at all times. Is that in your best interest or the financial advisor’s best interest?
To sum up, nobody is recommending becoming a market timer, but being aware of the stock market levels and trends can boost your long-term returns by helping you buy stocks or funds at more attractive levels over time.