In the last two years, financial markets, especially equity markets, have shown a remarkably positive performance, benefiting investment portfolios with more weight in this asset despite a context of political and economic uncertainty. As we can see in the graph below, the 2024 has registered a positive return of 24.9% especially in the US markets (in the graph represented the S&P 500 due to its long history available).
However, the average return of this index, which stands at 11.8%, is not very representative, as few years show values close to this figure. The dots in the graph corresponding to the different years seem more like darts thrown at random, illustrating the wide dispersion of results year after year and, therefore, the difficulty of getting it right.
Fixed income (bond) markets are generally less volatile, so they can be more predictable. But still, surprises arise: at the time of writing this post they are still recovering (still -10% below cumulatively) from the historically exceptional falls of 2021 (-2.2%) and especially that of 2022, -13.3% (see chart below). This figure is far from its positive average of 3.1%. In fact, negative years in the Global Aggregate Bond index are exceptional: only 4 years out of the 25 years of history available to us, 2 of them as we have seen recently.
Markets work in cycles, alternating periods of rises with corrections, and moments more favorable to one asset or another. In this context, you will often have doubts about whether you should adjust your risk profile or get out of the market and stay in liquidity or leave your money in a deposit or savings portfolio now that rates are positive.
At inbestMe, as experts in portfolio management and financial advice, we firmly believe that trying to anticipate the market or doing what is called “market timing”, i.e., trying to predict future movements, can be a costly and counterproductive strategy. Our recommendation is to stay the course as long as your financial objectives have not changed.
What is “market timing”?
Market timing, or trying to anticipate the market, is an investment strategy that attempts to get it right, buying assets when they are cheap and selling them when they are at their peak to maximize profits. Although it sounds attractive and easy in theory, in practice it is extremely difficult to execute due to the complexity and uncertainty of short-term movements.
Our psychology drives us to do “market timing”, it is inherent in us, we like to win. It is part of our nature to be speculators. The speculator is often influenced mainly by overconfidence, the illusion of control and confirmation bias. These biases lead us to believe that we can predict the market, control outcomes through our skill or knowledge, and seek information to validate our decisions. They are also influenced by our short-term perspective, which makes us react to daily movements, social imitation, which pushes us to follow the crowd, and the illusion of control, which makes us seek active decisions in an uncertain environment. Overcoming these traps requires education, emotional discipline and reliance on automated and diversified strategies to avoid impulsive mistakes.
Typically, this strategy is carried out unconsciously: keeping too much cash in a checking account, failing to make regular contributions during times of uncertainty, or disinvesting during periods of uncertainty.
Why is market timing so risky?
The main problem with market timing is that it requires getting two key decisions right:
- When to exit the market (sell).
- When to re-enter (buy).
This double-whammy is very difficult to achieve, as emotions and cognitive biases often interfere with the process. For example, during bull markets, greed can cause investors to hold positions expecting even higher returns, while in bear markets fear can lead to rash decisions. This is why market timing is so risky. Even if you get the exit right, you may miss the entry and vice versa, reducing the probability of success. Typically, market timing results in the opposite: buying high (because we miss the low) or selling low because we panic in a market correction when the markets are high.
Moreover, identifying market highs and lows is only evident with hindsight and no matter how much it is said, technical analysis serves to clearly identify in hindsight bear markets and bull markets, but not to systematically guess the future. During a period of uncertainty, markets can show mixed signals: sideways movements, false alarms or temporary corrections that do not necessarily indicate a prolonged decline.
Getting the timing of entry or exit wrong can have a significant cost. In fact, the best days in the market often occur during times of high volatility. Missing even a single day of strong rallies can have a considerable impact on the long-term value of an investment. We also saw how difficult market timing is in recent downturns.
Time in the market trumps market timing
We are aware that, for most, staying in the market when it is at highs seems the biggest risk, as there is the fear that it may go lower. However, this is based on the idea that we are able to accurately identify both the high and the subsequent low to avoid missing the recovery. This double hit, as we have already said, is virtually impossible to achieve, even for the most experienced practitioners. In fact, numerous studies have shown that staying invested in the market over the long term is more beneficial than trying to predict its movements. For example, a study by Vanguard, which we have already mentioned, analyzed different investment strategies and concluded that one-time investing usually outperforms even periodic investing two out of three times, with an average return approximately 2% higher over a 10-year horizon. The periodic or recurring investment that we ourselves recommend is simply a useful strategy to overcome our risk aversion.
The importance of proper allocation
At inbestMe, our portfolios are designed, among other things, considering your investment time horizon to determine the most appropriate asset allocation. Below are our main portfolios and the time horizons for which they are designed:
- Savings Portfolio: Ideal for investors with a short time horizon or who may need liquidity at any time. This portfolio focuses on monetary assets, offering moderate returns with minimal volatility.
- Target Portfolios: Designed for those who have a specific financial objective with a specific date. These portfolios combine high quality corporate bonds and fixed income assets, seeking to lock in an attractive target return at maturity. We offer different options according to maturity, from 2025 to 2028.
- Bond portfolios: These portfolios are designed to offer a diversified and more tax-efficient solution than investing directly in bonds or Treasury bills. They take advantage of the current positive interest rate environment and suit different risk profiles, with a cautious option for those seeking stability and a bolder option for those seeking a higher yield within fixed income and when the horizon is not as determined as in the previous case.
- Diversified portfolios: portfolios of index funds (or ETFs for non-residents in Spain) are recommended for investors with medium to long term time horizons. These portfolios offer a wide diversification in different asset classes and geographies, adjusting to the risk profile and objectives of each investor with or without SRI (socially responsible investment) style.
- Pension Plan Portfolios: Designed for those looking to plan for their long-term retirement, we offer 11 portfolio profiles, pension plans, with or without SRI (socially responsible investment) bias.
It is said by an unknown author, “It’s not about timing the market, but time in the market.”
It is essential to set aside market timing and focus on spending as much time as possible in the market, selecting and/or combining portfolios that align with your time horizons and financial objectives. An effective strategy is to diversify into several portfolios specific to each horizon and objective, which allows you to better navigate and manage the market’s inherent volatility. Only consider switching if your objectives have changed, not if there are downturns in the markets. In that case, take your time and make sure you don’t make hasty, panicked changes.
Even so, we understand that your speculative mind may still tempt you. If you decide to give in to that temptation, first make sure you have your objectives clearly defined and control your risk by dedicating only a limited percentage of your assets to speculation in a well segregated account so you can see how you are doing.
