Well, that was quite a year! As I write this, we are near the anniversary of the corona-crash. The turmoil of the last 12 months presented several lessons. Many of them aren’t new, but were merely delivered once again.
Here are a few of the lessons that had to be learned—or relearned.
Market Timing Is Hard
There are many reasons the majority of advisors strongly recommend against trying to time the market. The most important is simply that it’s really hard. Getting out before a drop or in before a spike is obviously a way to make a lot of money fast. Yet few do it successfully.
The corona-crash showed once again that making correct predictions about the direction of the markets doesn’t make timing profitable. Even if you got out at a good time, the window to get back in was rather brief. Markets rose fast off the March 23 bottom.
You have to be right about getting out, then right about getting back in, then about when to take profits. And you have to be right by enough of a margin to overcome the costs of moving around. That’s a lot of being right.
In taxable accounts, finding timing success is even tougher. Any short-term gains increase taxes.
The late, great Jack Bogle summed it up well: “I do not know of anybody who has done market timing successfully. I don’t even know anybody who knows anybody who has done it successfully and consistently.”
Even if all that works, you have another problem. You will almost surely be tempted to try it again. You might anxiously watch out for new market setbacks if Covid variants arise, political winds shift or a million other things go wrong. But something will convince you another crash is coming. If you successfully avoided one, you might be tempted to avoid another and you’ll seek out signs.
That temptation is great, and so is the stress associated with trying to predict market moves. Some people who start out as long-term investors succumb to the angst. They don’t know what’s about to happen, and switch from an approach that doesn’t require short-term market prognostication to one that requires them to be right about the market’s direction.
It’s a bad move that defies logic and is unlikely to cure what ails them. Hopefully, more people will see it that way.
Rebalancing Is Smart
Despite an incredible array of setbacks, markets have trended up. Long-term investors believe the aggregate value of businesses will be higher many years from now, and so the trends should continue. This means it’s smart to buy some of these businesses at lower prices when there’s a market setback.
It’s also smart to sell some stock after a large increase in prices. If you’re an investor with appreciated stocks, you have been rewarded for accepting risk. If you are prudent, you also believe in taking profits from that appreciation and reducing your risk, and you know that it’s better than trying to figure out when the stocks will actually peak.
This is what a rebalancing discipline asks of you—that you buy a little when prices are low and sell a little when prices are high. It allows you to keep a well-diversified portfolio with an appropriate risk profile. You don’t need to predict short-term market movements.
Here’s what I could have predicted about a crash, even before Covid-19 happened: that those who slashed equities in a crisis would do worse than those who froze and did nothing. That those who froze would be bested by those who rebalanced. And that those who rebalanced aggressively would do best of all.
When I look at client accounts for 2020, that is exactly what happened.
In the end, it didn’t matter if the crash was due to Covid or something else. It has been this way in every bear market and should be that way in every future bear market, because businesses are adaptable. In the aggregate, they should be more valuable in the future, and market values should reflect that. It’s just math and common sense. Buy low. Sell high.