I've been wary of market timing for a long while now. When I've pointed out how your returns would suffer if you managed to be out of the market on its best-performing days, some critics have asked me, essentially, "Well, what if you were smart enough to be out of the market on the worst days? That wouldn't be so bad, would it, smarty-pants?" (They haven't always addressed me as "smarty-pants," but I do get some flattering mail like that.)
They miss the point. Sure, being out of the market on the worst days would be wonderful. But how can you figure out when the worst days will be? You can't -- at least, not with any consistency. Every now and then, some financial prognosticator correctly predicts a surge or plunge, and gets feted by the commentators on financial TV. But that doesn't mean that all of his or her predictions will be correct.
Financial advisor Kim Snider recently pointed out at her blog how dangerous it is to try timing the market. As she notes, "The majority of a bull market's gains come in its first few days and weeks. If you wait until you see the market turn, you've already missed a golden opportunity."
She cited a Wall Street Journal article discussing a study by the folks at SEI Investments (Nasdaq: SEIC), who reviewed all the bear markets since World War II. According to the article, stocks rose an average of 32.5% in the 12 months following the bottom. Yet if you missed the bottom by just a week, that return fell to 24.3%. Waiting three months after the market turned cut your gain to less than 15%.
These arguments make me want to remain almost fully invested. I say almost because when I manage to, I like to keep some cash around, in case an amazing opportunity comes along. It's what many mutual funds do, too. The Fairholme (FUND: FAIRX) fund does that in a big way, holding up to roughly 30% of its assets in cash sometimes. Its five-year average is a market-trouncing 18%, and its top holdings recently included Sears Holdings (Nasdaq: SHLD), USG (NYSE: USG), St. Joe Company (NYSE: JOE), and Bristol-Myers Squibb (NYSE: BMY).
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