It’s never a good idea to try to time the market. No matter how you phrase it—you’re repositioning your portfolio, or avoiding the worst, or waiting for new opportunities—trying to guess where the market is going doesn’t work. With the UK deciding to leave the EU, Vanguard is reminding everyone of that fact.
We need to get back to basics to understand why market timing doesn’t work. The markets are fairly efficient, but that doesn’t mean they are perfect, or that they get every price precisely right. In fact, it might be better to say that they get every price wrong—we just don’t know which way. What market efficiency really means is that a security’s price is the market’s best estimate of its value, given current information. That last part is important, because it means that markets move on new information. And until we develop Psychohistory (and the person who figures it out is much more likely to work for a hedge fund or investment bank than a university), new information is equally likely to be better or worse than what the market expected. In other words, which way a security moves is a coin flip.
Furthermore, successfully timing the market (or making a “tactical portfolio move”) means you need to be right twice. Once to get out, but also once more to get back in. When you get out you’ve likely already taken some losses, so you are cementing those in, but after a drop in the market we tend to see pretty quick recoveries. So if you miss out on the recovery, you locked in your losses and didn’t get the gains you were entitled to for investing in the stock market.
What you want to do is focus on the long term. Over short periods, the markets are pretty much random. But if you stretch the time period, the market has a positive expected return. That long-term trend doesn’t mean that every year stocks are going to go up, or that even every five years they will go up. History has shown us, though, that the markets reward long-term investors. For some examples of just what this means, take a look at our Investing Through the Decades ebook.
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