Monday, August 25, 2008

Market timing or fully invested?

Research results and reality do not seem to mix well like water and oil. If you read a research like this, you will be compelled to stay fully invested. Will you go and spend your money today?
According to a report in the AAII Journal, one of the fundamental rules for effective retirement investing is to "Avoid the temptation to time investments based on what you - or the experts - "expect" the overall market to do."

From 1986 through 1995 an investment in the S&P 500 Index would have returned 14.8% annually if it remained fully invested for the whole period. However, if you missed only the best 10 days of that period, the return would have been reduced by a third to 10.2 percent. If you missed the best 20 days out of those approximate 2,500 trading days, your return was cut in half to 7.3%.

No, market timing is important but you will need to go against the crowd.

If you take a look at the first category - Large Cap Growth - you will notice that there were 9 quarters (# of Obs.) in the past 23+ years when inflows into this Large Cap category reached extreme proportions by historical standards and the corresponding valuation factor was above its average at the same time. The Large Cap Growth style under-performed the S&P 500 over the subsequent 2 year period in 7 out of these 9 episodes which resulted in the 78% success ratio (accuracy). Moreover, the average annualized under-performance relative to the S&P 500 was 2.1% for this style. Coincidentally, there were also 9 quarters of outflows coupled with a low fundamental factor, and those signals were correct in every one of these incidents generating an average out-performance of 4.2%. Finally, the spread between the high inflow/high valuation and outflow/low valuation strategies for the Large Cap Growth style produced an average annualized out-performance of 6.3% with an 89% signal accuracy.

If you time the market by going against the crowd when everyone is cashing out at low valuation, you will outperform the market by 13% from the period of 1979-2002.

The tricky part is catching the bottom. Let's turn to KLCI.

In 1997/98 crisis for example, it takes 18 months to bottom out. While during dot-com bust, it takes 15 months to bottom out. For this round of bear market, it is very uncertain whether it will take 15-18 months to bottom out.

Only liar will tell you they can catch the bottom, for me, I think it will be a good entry point after 11-12 months market topped out in January 2008 and fully invested.

But if you encountered a situation of mild rally from 2002(G)-2006(H), does that means you don't invest at all?

No comments: