For many investors, the temptation to try to time the stock market is irresistible. However, for most investors, market timing is as dangerous as it is irresistible. In my last market timing post, I discussed the downside of missing a few good return days. In this post, I discuss the downside of trying to time allocation to sub asset classes in your portfolio.
To demonstrate the difficulty in predicting the movements in stock prices, I present the chart below. What may appear to be randomly placed colors is actually the returns of major investment sectors displayed on an annual basis. Each year, the returns are listed best to worst. Also included is a portfolio that was equally invested in each of the sub asset classes. I do not present the portfolio as an investment recommendation. Instead I offer it as an example of how discipline and diversification can make market timing unnecessary to achieve long-term investment goals.
Research indicates that stock prices behave in an almost random pattern. The movement in price up or down yesterday offers very little information about tomorrow’s price movement. This applies to both individual stocks and sub asset classes. Close inspection of the chart reveals that this year’s winner is often next year’s poorest performer and vice versa. Therein lies the trap. It’s human nature to extrapolate the most recent past into the future. In investing, this tendency to extrapolate can be and often is extremely dangerous.
In my investment career, I have found that a diversified and disciplined portfolio is the most reliable long-term wealth building strategy. Hopefully, this chart will serve as a reminder that market timing is not a necessary component of a long-term successful investment and wealth building strategy.