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Mistiming the Market Roller Coaster

roller-coaster“Retirement Investors Flock Back to Stocks” was the front page headline of The Wall Street Journal on May 2, 2014. I retweeted it to my Twitter feed, adding, “Just In Time To Ride Them To The Bottom Again.”

Five years ago some of those same investors were abandoning stocks in sheer panic. In early March 2009, the Dow Jones Industrial Average hit a low of 6700. Many financial advisors spent hours listening to frightened clients wanting to sell out their entire portfolios and go to cash. It was an exhausting and traumatic period for advisors and clients.

Those who followed advisors’ recommendations to stay the course certainly came out on top. Their portfolios recovered nicely, with double-digit annualized returns for the past five years. Even over the past 10 years, most diversified portfolios earned very respectable returns far in excess of bank CD’s or bond yields.

Unfortunately, those who panicked and sold out paid an incredibly high price for the momentary relief of getting off the market roller coaster. Many of them kept their money on the sidelines until recently, waiting until “things were better” to reinvest.

Apparently that time has come. Here are some numbers from the WSJ article: Retirement investors have recently increased their stock holdings by almost 40% from the market lows. Today, bond and money market funds make up only 25% of retirement plans, and 67% of new 401(k) contributions go toward purchasing stocks. In 2007, bond and money market funds accounted for 21% of retirement plans. At the market top in October 2007, the average new 401(k) contribution going into stocks was 69%. Within 18 months stocks had declined almost 60% from their highs.

Do you see any potential correlations here? I have little doubt these individual investors, mistiming the market once more, are setting themselves up to get slaughtered all over again.

But what about those who did get out of the markets five years ago and now realize they made a big mistake? Suppose you’ve learned the wisdom of staying in the market with a well-diversified portfolio. How do you get back in without waiting for the next crash?

Here are three strategies to rebuild your portfolio. First, don’t go all in, but move into the market gradually with “dollar cost averaging.” Over the next two years, methodically (monthly or quarterly) buy into a diversified mixture of asset classes. If the market turns downward, which carries a high probability, you will buy into a falling market. You will also reduce the possibility of a huge market drop that might cause you to panic and sell out again.

Second, allocate your purchases to a mixture of US and international stocks, as well as options such as real estate investment trust (REIT) funds, commodity funds, managed futures funds, treasury inflation protected (TIPs) bond funds, high yield bond funds, and high quality bond funds.

Finally, once your two-year dollar cost averaging is done and you are fully invested into your asset classes, rebalance at least once a year to maintain your original allocations as the values of the assets change. For example, if you have allocated 30% of your portfolio to stocks, purchase more if stocks add up to less than 30% or sell some if they are over 30%.

The research suggests there is a high probability that things will end badly for individual investors who try to time the markets. A few will succeed, but will confuse their “skill” with the fact they just got lucky. A methodical approach, however, provides a strategy to help you hold on, even in the face of market ups and downs.

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Related Reading:

Find Out Hidden Costs of Guaranteed and No-Fee Investments

Risk of Comparing Portfolio Apples to U.S. Stock Oranges

Investment Success Based on Client Behavior as Well as Portfolio

Important Questions Investors Fail to Ask

What Investors Want to Know but Don’t Know How to Ask

Dare to Be Boring: Invest, Don’t Speculate

401(k) Investment Choices Not One-Size-Fits-All

Can You Trust the Stock Market?

The Investment Value of Delaying Social Security

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