I am a professional investor and have timed the market with some success, but not too much as it is very hard to do. But I think novice investors should try to time the market once or twice in their investing career. Sacrilege, I know. I’m not talking about fully entering or exiting the market, but rather making changes to asset allocation that have the potential to significantly increase returns over time.
Here’s how it works. Imagine you have your money in index funds in a traditional 60/40 portfolio. This means 60% in a stock index fund and 40% in a bond index fund. The time when you feel most excited about your portfolio, when it seems like it’s growing the most every day, and you can’t believe how much you’re earning, is when you want to adjust your stock allocation to 50%.
A friend of mine, Brent Donnelly, president of Spectra Markets, calls it “The Cheer Hedge”. It was since he was working at a currency exchange where he observed that the moment someone made a lot of money and started clapping with others was when the post stopped working. If, at the time when you were most satisfied with your investments, you reduced the risk, you would probably be on the way out of the market at the tops. When you feel the need to tell everyone how much you earn, it’s usually when the piano is about to fall on your head. It would have worked exceptionally well during the dotcom bubble and into 2021.
Likewise, when you’re feeling the worst for your wallet, when you’ve given up hope and are considering liquidating everything to stop the pain, it’s probably time to take more risk. If you increased your equity allocation from 60% to 70%, you would have more exposure when the market inevitably rallies. In the depths of the financial crisis, if people were increasing risk rather than liquidating, they would have been much better off today.
For example, in a year where stocks return 15% and bonds 5% in a 60/40 portfolio, the blended return would be 11%. By adjusting the proportion of equities up to 70% and bonds up to 30%, the yield increases to 12%. A small but noticeable difference. Of course, in the early days of the post-financial crisis market, stock returns were much higher, with the S&P 500 index gaining 23.5% in 2009. Alas, many missed out on such gains. Surveys by the American Association of Individual Investors showed that most novices had only 41% allocated to stocks at the time.
Financial advisors say it’s impossible to time the market, but it really isn’t. If you can detect big shifts in sentiment, you can make subtle changes to your asset allocation and increase returns over time. But it forces people to go against their intuition, which is hard because when people feel good about their portfolio, they usually want to buy more stocks and sell when they feel bad. Humans are wired to be terrible investors. So if you were to do the opposite of what your instincts tell you, you’d probably be better off. This is not heretical advice. The legendary Warren Buffett often said that being a successful investor once had to be fearful when others are greedy, and greedy when others are fearful.
Some people might interpret this advice as permission to actively trade, but that is not the case. I’m talking about extreme feelings that only happen once every 10 or 15 years. One of them came during the first half of last year, when meme stocks were spinning in space and crypto millionaires were hit by the thousands. You can watch magazine covers and the like, but the best way to gauge sentiment is to talk to your neighbors. If they’re telling you they’re gaining or losing tons of cash in the market, it’s probably time to change your portfolio.
This latest stock market pullback wouldn’t be considered extreme sentiment – at least not yet. We have to get to the point where people believe the economy is going into a depression and the stock market will fall to zero, and there doesn’t seem to be any sort of mass capitulation. Sure, the latest AAII data shows the percentage of bulls hovering just around 30-year lows, but it’s also worth noting that Cathie Wood’s flagship ARK Innovation ETF – considered the ultimate barometer of the Pandemic-era investor exuberance – posted its longest streak of weekly inflows in more than a year.
The goal is not to select highs or lows with precision; it’s about taking a little less risk when others take more, and vice versa. People try to achieve this in different ways, such as studying things like ratings or charts, but the best way is to use sentiment. Novice investors have a voice in their head telling them to do the exact wrong thing at the wrong time. If you can step back and have some awareness of your own emotions, that’s what produces long-term outperformance.
More other writers at Bloomberg Opinion:
• Some Unsolicited Recession Survival Advice for Gen Z: Erin Lowry
• Gen Z gets a hard lesson on stock market risk: Allison Schrager
• Beware of a bear market that is more than a bear cub: Nir Kaissar
This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.
Jared Dillian is the editor and publisher of Daily Dirtnap. Investment strategist at Mauldin Economics, he is the author of “All the Evil of This World”. He may have an interest in the areas he writes about.
More stories like this are available at bloomberg.com/opinion