‘Great things are not accomplished by those who yield to trends and fads and popular opinion.’ Jack Kerouac
‘Time in the market’ and ‘market timing’ are long-accepted mantras of the investment industry. Even though they are accepted as ‘ways’ to invest, they do not guarantee investment success.
When you buy a stock matters more than time in the market
The general view is that ‘if you buy and hold for long enough, you will always do well’. This has led to a rise in the prominence of index-based investing.
The S&P/ASX 300 Index illustrates the fundamental flaw in this theory. If you had invested in this Index in 1970, you would be no better off today than when you first invested (taking into account inflation and excluding dividends). This is despite remaining invested for almost 45 years. The ‘time in the market’ way of investing relies heavily on the benefits of compounding, but your level of investment success ultimately depends on when you buy.
The inherent flaw of index funds is that, by virtue of their construct, they operate against the most basic investment principle of buying low and selling high. Indices are forced to buy overpriced stocks and sell those stocks for a price that is lower than their value simply because they are constituent stocks of the index.
Speculation and momentum are two of the main drivers of sharemarkets. You should look beyond these drivers to identify true value and a good point to buy. In the very long term, the market will eventually reflect the true value of individual stocks. However, it is unlikely that all shares in the market will reflect fair value at the same time. Investors should therefore make use of the opportunities presented by short-term inefficiencies.
Follow a valuation-based approach to get the best results from ‘timing the market’
The average investor use of ‘timing the market’ reflects buying stock at a certain point in time because they believe it is ‘going up now’. The trap is that this only focuses on potential benefits and often ignores the reality that it may take some time for the stock to ‘go up’, or that it may go down. A far more effective way to take advantage of market timing is to take a valuation-based approach by buying when the stock is trading at a discount to its valuation. When to sell depends on the stock price relative to its valuation and having the patience and discipline to wait.
Timing your entry to the market is still important. However, the determining factor should not be where momentum will take the market as a whole, but what opportunities lie within the market. Buy companies that are cheap relative to their valuations and allow that to dictate when you invest. Even when a market is trading at an all-time high, there will be individual stocks that are trading at a discount to their intrinsic value. Time and timing are both important, but they aren’t as important as the price you pay.
Make the most of time and timing by following a contrarian approach
Conceptually, time in the market and market timing are not all bad. After all, without time in the market, you lose the benefits of compounding. The best approach to gaining advantage through timing and identifying when to ‘get in’ is to focus on valuation.
Active management and individual stock selection provide the benefit of not having to rely on the rare opportunities to ‘buy the market cheap’. The period of time you remain invested will depend on when the stock reaches its intrinsic value, and your level of patience and discipline to see it through.