The S&P 500 has enjoyed an eight-year bull market with an average annual return of 19.4 percent. Starting in 2019, U.S. companies will benefit from a massive cut in the corporate tax rate from 35 percent to 21 percent. This provides them with the opportunity to make significant investments in expansion, perhaps extending the investment growth rate even further.
On the other hand, with partisan politics as divided as ever and the presidential administration under investigation for collusion with a foreign adversary, a single bad news day has the power to sink stock markets across the globe. Thus, the current scenario presents quite a conundrum for investors.
Even without the new tax reform bill, some analysts have cautioned that the markets are overdue for a correction. However, if investors heed this call and sell, they could miss out on substantial growth opportunity in the coming year. There is a term for contemplating investment changes based on economic and political events – it’s called market timing – and is usually deployed by investors willing to take significant risks.
Market timing is the opposite of the buy and hold investment strategy. It involves buying and selling stocks based on market, economic or specific company fundamentals that have the power to influence stock prices over a short period of time. Investors may take advantage of gains derived from rising prices and avoid losses when they decline by basically jumping in and out of the market at will.
Unfortunately, a severe disadvantage to this strategy is that no one – not even experienced wealth managers, stock brokers or market analysts – can accurately predict when prices will rise or fall. Moreover, security prices do not always move in tandem, so while an investor might correctly predict a trend, he might not select the stocks that benefit from sudden, dramatic movements.
While market timing is considered a risky strategy, there are cues investors can use to help guide their decisions. For example, historically markets have often climbed to their greatest heights just before a fall. But again, no one knows when this will happen. If market timer sells too soon, he would miss out on the greatest gains. If he waits too late, he could see his potential earnings decline. Then there’s the recovery period. In the past, the worst bear markets fell quickly but then recovered just as fast. A market timer will want to buy back into the market at the right time or risk losing out on opportunities as stock prices begin their ascent again.
There are several caveats associated with market timing. First of all, it is more appropriate for investors with a high-tolerance for risk. It requires considerable research and continuous monitoring of the overall markets and specific securities of interest. Tactically, it can increase investment expenses – such as trading fees and capital gains taxes. And finally, be aware of the types of assets best suited for timing. For example, it may not be wise to drop dividend-paying stocks precipitously, since many continue to pay out and even increase dividends over time regardless of market declines.
Market timers also should be cautious about their financial situation and stage of life. In other words, if nearing retirement it might not be wise to use retirement assets for a market timing strategy. In fact, it’s a good idea to segment a portion of an investment portfolio for timing strategies so as not to impact assets designated for other goals, such as saving for a home or college expenses.
On a final note, recognize that market corrections are inevitable whether engaged in market timing or not. The potential for loss is an inherent consequence of investing. Rather than try to time the market, another way to offset losses is to invest automatically. By investing regularly over time, investors can take advantage of buying more shares when prices are low and simply buy fewer shares when prices rise. Either way, automatic investing gives you a way to continue increasing market value without having to engage in timing strategies.