You Can't Time the Market
As I write this column, the S&P 500 was down almost 3 percent from its Friday close -- or, for the optimists in the room, up more than 2 percent from its morning bottom. One is tempted to send the market a gentle note inviting it to really spend some time getting to know itself, maybe work through some issues in therapy, channel its highs and lows in a productive direction.
The proximate cause of this chaos is the meltdown in the Chinese stock market, which has prompted a global selloff in financial markets. You financial pros probably have a lot of important questions. Does this herald a Chinese recession, and if so, what does that mean for the rest of the world's major economies? If America's economy slows down, how much room will the Fed have to loosen after seven years of holding interest rates to the zero lower bound? What does this tell us about the limits of both fiscal and monetary policy in the face of long-term real shocks and structural weaknesses in the underlying economy?
But this is a market move so big that even those of you who are not financial pros are asking more prosaic questions. Like "What does this mean for my 401(k)?" Luckily, we live in the Internet age, and you no longer have to wait for a quarterly statement, or call your broker in a panic. You can log on right now and look. My advice is: Don't.
Unless maybe you're planning to retire tomorrow. Are you planning to retire tomorrow? I don't mean "soon." I mean, are you planning to retire on Aug. 25, 2015? Because if not, there's no reason for you to be looking at the day-to-day movements in your 401(k). You probably lost a lot of money in the last week. And you know what you can do about that? Nothing.
Oh, sure, you could try to time the market by selling now, waiting for it to bottom, and buying back. A lot of people get rich doing this in novels, particularly novels set in the Great Depression. You know why they're able to do this? Because the author gets to cheat; they have the prices right there in front of them, and they can whisper them to their character, maybe along with a plausible rationale as to how they should know this is the top, and then recognize the bottom when it comes along. In the real Great Depression, a lot of people took a bath attempting this strategy, because what they thought was the bottom turned out to be a temporary pause before the market dropped into the basement, then got out a pick and a shovel and started digging through the bedrock.
Ah, but financial professionals will protest that many people in their industry do sell into a crash and then pick up assets on the cheap. True, though my experience is that you are more likely to hear about the times this was a winning strategy than the times when it was not. More importantly: Are you, dear reader, a financial professional who spends all day glued to the market data feed, watching for the bottom? Or are you the sort of person more likely to park some cash in your trading account in preparation for that golden moment to buy ... and then forget about it for six months because Mom had a nasty bout with pneumonia right after you had to shepherd Junior through the college application process?
Attempting to time the market, like most other active trading strategies, produces at best a modest premium that roughly pays for the work needed to generate the excess profits. (At worst, you lose much more in herd behavior and trading fees than you gain in value.) But that's for people who do this for a living. The odds that you, who have so many other things to think about, are going to wade into the market and outperform the professionals are approximately the same as the odds of you getting up out of your armchair, wandering down to the nearest major league sports arena, and outperforming the folks on the field.
That's why all the best financial advice is to buy broad market funds and then just hold them. I've interviewed a fair number of finance professors over my years as a columnist. These people spend their lives studying how to make money in financial markets. You know what they do with their nest eggs? That's right, all the ones I've ever talked to had the overwhelming majority of their money in the same boring Vanguard or TIAA-CREF index funds.
As you get older, you can shift more of your investment portfolio toward bonds, which offer lower but more stable returns. But you should not be trying to pick mutual funds (you won't be any better at this than you will be at picking individual stocks, and historical performance data don't tell you anything useful about what will happen in the future). You buy an index because it's diversified -- you won't be undone if a major company suddenly goes bankrupt -- and because it's cheap. Fees are low because the fund isn't paying a battalion of analysts and managers to pick stocks; the fund just mirrors the broad market.
And then once you've bought index funds, you're done. Don't look at your statements unless you need to for planning purposes -- to figure out whether you're on track for the retirement you want, and calculate how much more you need to contribute, or how much lifestyle you need to cut back. Otherwise, your mutual funds should be out of sight, out of mind. I see our mutual fund status about once a month, and that's only because we have accounts outside of our employer-sponsored retirement funds that I have to manually purchase fund shares for when I transfer money in. I do my best to ignore it.
If you look, you will be tempted to do something. And if you do something, the odds are that this will be the wrong thing, something that will cost you money. Market tops and market bottoms are fundamentally herd behavior. And while I'm sure that every cow in the herd feels that she is special, just a little bit more insightful than the average cow, collectively they are a bovine mass.
Of course, indexing is a herd strategy too. But it's less of a stampede from some imagined danger, more of an amble toward green pastures. And it works.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
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Megan McArdle at firstname.lastname@example.org
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