I often get questions to the effect of “I recently read about [some investment strategy]. Is that a good idea, or would it count as market timing?”
The answer, of course, is that it doesn’t matter whether or not an investment strategy “counts as market timing.” All that matters is whether or not it’s a good idea.
It seems to me that the market timing label has been applied to any strategy that has anything to do with interest rates or market valuations. And all such strategies have been declared taboo, despite the fact that there’s a huge variation as to:
- The level of risk involved and
- The probability of success.
To illustrate what I mean, let’s take a look at a few example strategies, any of which could be described as market timing, depending on who you ask.
Moving Between Cash and Stocks Everyday
Strategy 1: Bill moves his entire portfolio between 100% cash and 100% stocks from day to day in an attempt to catch the best days in the market and miss the worst ones.
Bill’s strategy relies on predicting what the market will do tomorrow–a feat bordering on impossible in the absence of super-human powers. And if Bill fails, he could lose a significant portion of his portfolio. This type of market timing is not a good idea.
Shifting Your Bond Maturities
Strategy 2: When real interest rates fall far below their historical averages, Larry shifts his bond allocation toward shorter maturities. Larry plans to wait until rates come back up, at which point he will switch to longer-term bonds to lock in those rates for a longer period.
Larry’s strategy is essentially a guess that interest rates will soon return to their normal range. Larry could be right, or he could be wrong. But if he’s wrong (and interest rates do not rise any time soon) the worst-case scenario is that he misses out on the slightly-higher returns that he could have gotten by holding longer-term bonds.
Moving from Stocks to Bonds (for Good)
Strategy 3: Laura is planning to retire in the near future. Her portfolio has recently grown a great deal due to a couple good years in the market. Because interest rates are currently high [obviously a hypothetical example], Laura decides to shift a significant portion of her portfolio out of stocks and into long-term TIPS (or an inflation-adjusted fixed lifetime annuity).
Laura’s strategy is based on recent market performance and current interest rates, but it doesn’t rely on any prediction at all. It’s simply a decision that current rates are good enough to carry her through retirement with very little risk.
Market Timing Doesn’t Mean Much
Because of the taboo we’ve placed on anything that could be described as market timing, investors are sometimes afraid to use all the available information when making their decisions. I do not think this is a good thing.
It’s OK to make investment decisions based on current interest rates or market values, so long as you remember that you can’t predict where they’re going next or how long it will take before “next” occurs.