The Minnesota Investor: 'Timing' the market seldom works

  • Article by: ROSS LEVIN
  • Updated: June 21, 2008 - 9:03 PM

Don't confuse cause and effect or profitable investment calls with wisdom. Randomness could be the explanation.

Had I been a better interview, I could be single and still trying to figure out what type of work I should be doing.

When I applied to be an orientation leader at the University of Minnesota my sophomore year in college, I didn't get the job. I was crestfallen. I got it the next year, though. And as luck (or randomness) would have it, my future wife also got the job. So did the wife of my future business partner.

So here I am, 28 years after the fact, looking at my pretty good life, and thinking if I had only been a little bit more articulate, a wee bit more convincing, a tiny bit more passionate, my life may not have turned out nearly so well.

In "The Drunkard's Walk -- How Randomness Rules Our Lives,'' Prof. Leonard Mlodinow says: "When we look back in detail on the major events of our lives, it is not uncommon to be able to identify seemingly inconsequential random events that led to big changes."

This makes sense as we retrospectively focus on what happened, but this also is true with what never happened. For example, we don't know if the wrong turn we took helped us avoid an accident. In the field of financial planning, I think about these things all the time.

One of my clients had called in March to tell me of his retired neighbor who had sold out of everything right before the market fell last fall. This incredibly prescient person was planning to sit on the sidelines until the Dow fell to a certain level. She would then venture back in. While I have a great relationship with my client, I don't think he was telling me this anecdote simply to have a conversation. Unstated, but implied, was: "How come a smart professional like me didn't sell everything at the same time she did?''

So, is this an example of my idiocy or her brilliance -- or both. Or neither?

From Mlodinow: "Random events often look like non-random events, and in interpreting human affairs we must take care not to confuse the wo."

In order to understand whether this neighbor was an undiscovered Warren Buffett, citing this one market call is not sufficient. In fact, uncovering several correct market decisions may not be enough. If you look at the universe of investors, basic probability teaches us that someone is going to make great market calls several times in a row simply by chance. The problem for any of us is determining when these market calls are inspired or lucky.

So now what?

Since March, the Federal Reserve continued to cut interest rates, and the markets had been up double digits from their lows. Because the Dow never hit this neighbor's reentry point, she is sitting on a pile of cash that (because of that sneaky Fed) is earning less and less. So now what does she do? Stick to her guns or bite the bullet? This week, the Fed is meeting again, and there's speculation that it will either hold rates where they are or raise them in response to growing inflation.

This is not to say that the market won't fall from here -- rest assured that it will. But know that it will go up from here, too. This is simply to say that if you are investing your money for a period of more than three years, it is foolish to be trying to time getting in and out because there are so many somewhat random variables that cause short-term volatility. But equally silly is to be invested all in one type of investment -- be it an index fund or a hedge fund -- because of those same variables.

Stocks always are priced on some vision of the future. Day-to-day, emotional responses cause prices to move up and down. But over the long run, stocks move in particular directions because of the underlying strength or weakness in the companies. Think about it as the difference between weather and climate change. Just because it is colder this year than last year does not mean that the ozone layer has stayed intact. The weather changes all the time for varied reasons; the question to answer is what is the long-term direction.

Large stocks, small stocks, growth stocks, value stocks, U.S. stocks and international stocks all move upward over long periods of time because economies grow over time. But they are mispriced daily. Eventually, they move back in line. This is based on the scientific principle pointed out by Mlodinow that "processes that [do] not exhibit regression toward the mean would eventually go out of control."

That is partly why growth stocks got crushed early in the decade. It also is why you want to invest in multiple asset classes and rebalance your winners back to your losers.

Beyond the market, randomness is everywhere we look. You can improve your chances for better outcomes through multiple attempts at the things that are important to you. Had I not gone back to apply for that orientation-leader job again, you would probably not be reading about my wife, our twins and my business in these monthly columns.

Spend your life wisely.

Ross Levin is the founding principal of Accredited Investors Inc. in Edina. He is a certified financial planner and author of "The Wealth Management Index." His Gains & Losses column appears on the fourth Sunday of each month. His e-mail is ross@accredited.com.

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