How shall we judge whether you should try to take advantage of this?
Market strategies: Dollar Cost Averaging versus Absolute Bottom Buying Strategy
Dow Jones Industrial Average Index from 1970 - 2020. This is a period of 50 years which spans inflationary and deflationary cycles and which has seen several crises and crashes as well as bull markets. It seems like a long and fair sample period.
Imagine that over this 50-year period there are two competing investment strategies.
- One is to invest an equal amount every trading day throughout the period irrespective of market conditions - the so-called dollar cost averaging.
- The other strategy requires enough foresight for the investor to invest the same amount daily, but to stop investing when the market turns down and save the cash. This money is only invested when the Dow makes a new bottom, hitting its low point in any period of decline (hence why it is known as an "absolute bottom buying strategy").
This is a somewhat more realistic example of how you might apply foresight, rather than measuring what would happen if you had such certainty about the future you were able to sell everything just before the market turned down and then buy it back at the bottom.
Over the 50-year period, the second strategy would have produced returns 22 per cent higher than the first.
It sounds impressive - perhaps a little less so when you break it down to a 0.4 per cent outperformance per year
But think of the time and effort you would have to spend monitoring markets to get those calls just right.
Possibly foregoing any significant gains
Since March 2013, the Dow is up just over 150 per cent in total, averaging 13.3 per cent per annum.
Imagine if you had acted on market fears and taken your money out of equities or stopped investing ahead of that performance.
Should you risk foregoing any significant portion of that gain for a maximum upside of 0.4 per cent per year.
Nobody has perfect foresight:
- wrong about the events and
- wrong about the market's reaction to events
In reality, attempt to implement the second strategy will almost certainly cause harm to your net worth as nobody has perfect foresight. In your desire to time the markets, you will stop investing, or worse, sell and take money out when you expect the market to go down and instead it goes up.
Think back to Brexit and Trump's election. We were told by most commentators that they wold not happen, but if they did, the markets would plunge. Not only were they wrong about the events but they were also wrong about the market's reaction to events. The markets soared.
There are only two types of investors
When it comes to so-called market timing, there are only two sorts of people:
- those who can't do it, and
- those who know they can't do it.
There is a lot to lose and little to gain from market timing.
Reference: The Financial Times