Investors have been enjoying an unusual period where the wind has been at the back of most major asset classes for the last few years. With the exception of commodities, which continue to do poorly in 2014, and emerging markets equities, which were poor performers until perking up this year, all other major asset classes have turned in good performances since the end of the financial crisis of 2008-2009. The great returns have also come in a period of extremely low volatility where daily price swings have been small compared to historical levels and mostly in the upward direction.
Our human nature tends to build confidence after periods where making money has been relatively easy and without a lot of stress. Of course, history has shown us these periods have never lasted forever. The current upward trend in stock prices is now the fourth longest ever, and there is evidence that some of the money fueling the run is being invested by individual investors.
These individuals, as a group, have historically been a bit late to enter and exit the market. It doesn’t mean that the stock market is ready to collapse in the immediate future, but there will be a change in direction at some point and investors should have a plan of how they will react to a downward trend in prices. There are two basic styles of approaching this.
The first is a buy and hold approach. Buy and hold has been proven to work over time, but the key part is to be willing to hold when things get a little nasty, rather than hitting the panic button and selling after a large decline has already occurred. One way to combat the emotional aspects of investing is to employ a very diversified allocation across your portfolio. Holding a lot of different types of assets can buffer the volatility compared to holding 100 percent in stocks. Government bonds may well rise in price when stock markets are in decline, and other types of investments may go down in price, but not nearly as much as the more volatile equity asset class.
The second is a tactical approach. Opinions vary widely on the prospects for the success of market timers who vary their portfolio allocation over time. Selling all or part of your stock positions before a decline progresses too far, in favor of holding cash or government bonds, may be a successful strategy. Buying back those stock positions at lower prices later is the obvious goal.
I don’t believe that very many people are successful at market timing when approached in a subjective manner, using opinions based on interpretation of news events or market data. There is, however, statistical evidence to support the idea of using formula based methods for deciding when to buy and sell different asset types.
Note that I did not say these formula based methods were perfect. Small failures are to be expected when applying mathematical logic to prices which are ultimately decided by human emotions. I do believe that being right in a big way at major turning points and wrong in a small way every now and then still works out in the investor’s favor if he or she sticks with a method based on strong historical evidence.
Sticking with the approach you favor is far more important in determining your success than worrying about whether you selected the right model, and constantly changing strategies.
Tom Breiter is president of Breiter Capital Management, Inc., an Anna Maria based investment advisor. He can be reached at 778-1900. Some of the investment concepts highlighted in this column may carry the risk of loss of principal, and investors should determine appropriateness for their personal situation before investing. Visit www.breitercapital.com.