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Wednesday, October 29, 2008

The Mole Says, Don't Bale on the Market Now

NEW YORK (Money) -- Question: I know market timing is a loser's game. However, I do think there is abundant evidence that the next 12-18 months are going to be very difficult for equities. Do you see any merit in trimming some equity holdings, parking the proceeds in short-term bonds or cash, and committing to immediately dollar-cost averaging back into the market on a monthly fixed schedule?

The Mole's Answer: Your question is a very sophisticated way of asking whether you should bail from the market right now. While I don't know your total situation, I can tell you that selling after equities are down by 40% is usually a bad thing.

First of all, I wholeheartedly agree with your statement that market timing is a loser's game. Many studies have shown the systematically bad job that individual investors do of timing the market.

We are constantly testing the market winds. When conditions are favorable, we increase our exposure. When conditions become so far from favorable that they're in another zip code, such as what we're currently experiencing, we decrease our exposure.

Unfortunately, we tend to do both of these things after the fact. Truth be told, we all want stock returns during bull markets and money market returns in bear markets. But as much as we may want them, no one really knows exactly how to get them, since we can't predict when bear markets and bull markets are beginning or ending.

Second, when you state that the next 12-18 months are likely to be "difficult" for equities, I'm not sure I agree with you. If by "difficult," you mean volatile, then you are probably right.

The last few weeks in the stock market has set all sorts of records for volatility. Emotions are running wild and there is a likelihood that this volatility will not end anytime soon.

But I would not agree that this translates into a bad period for the stock market. Primarily because the stock market is a better buy today than it was last year. In fact, I can quantify it by saying it's a 40% better value.

Which begs the question, why wasn't I getting as many inquiries about selling last year when the market was hitting new highs?

But that's a rhetorical question - the answer is that we humans have a tendency to predict the future based on the recent past.

This "recency bias," as it's known in the financial planning world, has us thinking inside the box of current events. If the market is thriving, as it was between 2003 and 2007, then we believe it will always be thriving. And in times like these when the sustained market dive is giving us all nose bleeds, we believe we'll never pull out of it.

Onto your question of whether you should sell now with a commitment to buy back in with periodic purchases, also known as dollar-cost averaging. As sophisticated and well thought out as this sounds, it still means selling your equities after they are down by 40%, and still equals market timing.

A better time to consider selling would have been last year after equities had more than doubled.

I can't tell you how the stock market will perform over the next 12 -18 months. No one can. It may very well turn out to be the right thing to do but the odds are very much against you.

Studies actually quantify that we pay an average penalty of 1.5% annually for timing the stock market and chasing the hot performers. Many of us come up with all sorts of rationale for doing what we're doing, but it ultimately just results in outsmarting ourselves.

The fact that you say you will commit to buying back periodically is a bit confusing. I'm glad you realize the market doesn't signal to us that we have hit bottom and that now is the time to buy, but it also hasn't sent you a signal that now is the time to sell.

Systematic rebalancing would have had you selling some of your stocks between 2002 and 2007, as they were skyrocketing. Now is probably when you should be buying.

My advice: Find an asset allocation that is right for you and stick to it. Try to rebalance in times like these, which actually means buying more stocks. Remember that investing during a rough economy can be the right thing to do. If someone tells you that you can have the upside of the market without the risk, don't believe them.

The Mole is a certified financial planner and certified public accountant who - in the interest of fairness - thinks you should know what goes on behind the scenes in financial planning. Want to make contact? E-mail him at


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