by Trivirus
A few days ago I incinerated one of Wall Street’s favorite myths: “buy and hold.” The reasons are obvious: stock market crashes can be severe and the recovery time-consuming (Dow took 25 years to recover its former peak value from 1929), and if it’s so great, why aren’t Wall Street managers doing it themselves?
Here are some additional lies that should have died a long time ago, but haven’t.
Lie: You can’t “time the market.” Markets move sporadically and randomly. To successfully “time the market” requires entering and exiting successfully, which most fail to do.
Why it’s bogus: I will concede that the average investor is pretty awful at timing markets. But this is like saying, “Don’t try to bench press more than 135 pounds,” which is what the average man is capable of. There are people who can bench 200, 400, and even 1000 pounds. The point is that if you want above average returns, you need to be above average. This is hardly a foreign concept to anyone.
Passive investors, or those who rarely touch their investments, can rely solely on macroeconomic data (wages, unemployment, bankruptcy, inflation, yield curve) to obtain a good glimpse of the overall environment, and time their exits so they don’t get caught in the downward spiral. Bad economic news back in 2008? Pull your damn money out! Imagine NOT having to lose a whopping 50% when the SHTF. You would be WAY ahead of everyone else.
Active investors have even more tools at their disposal – technical analysis of individual stocks and the stock market as a whole. Using a simple example – the RSI (Relative Strength Indicator)
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Now, you don’t have to be genius to figure out that buying the stock market when the RSI is high is going to be less profitable than buying when the RSI is low. There are obviously other metrics you can use (Bollinger Bands, SMA, etc.), but this alone already tells you a lot.
Nobody can time the market perfectly, but good timing beats bad timing hands down, and it’s not difficult to do.
Note that I am not talking about day trading – I’m talking about buying and holding securities for months or years. Timing just one entry and exit properly over a long period of time makes a large difference.
Lie: Dollar Cost Averaging (DCA) is the best way to invest. Dollar Cost Averaging takes no effort. Just invest a set amount every month, regardless of the current price of the stock or ETF, and forget about it. The upside to DCA is it takes emotion out of investing, and you buy more if the security price is lower.
Why It’s Bogus: Experienced investors often joke that people who mindlessly DCA end up “dollar cost ravaging” instead. But let’s examine the logic and numbers.
DCA Assumption: “The stock market always goes up in the long run.”
Reality: This has been true for the USA, at least, not so much for other stock markets (Japan). But let’s ignore that chink in the armor for now (and the possibility stock returns WON’T be 7% in the future).
If markets go up in the long run, why not invest your entire amount all at once? (Lump sum investing)
There have been many studies on lump sum investing vs DCA (you can look them up). There are almost no differences in outcome. In other words, if you’re really lazy and simply don’t care to do research, you may as well go with lump sum investing.
The proverbial nail in the coffin can be further hammered into the casket using the following scenario.
Suppose I told you to to pick 30 random stocks, organize them on a dartboard, and throw 10 darts – the ones you hit are the ones you invest in. 1 year later, you compare the results with the SP 500 Index. Congrats! You managed to beat the overall market.
Now let me ask: Would you conclude this is a “good strategy” for picking stocks? After all, you managed to beat the market, right?! Would you do this over and over again?
No? Well, friend, I have news: neither is DCA.
The reason DCA is on as much solid ground as throwing darts at a board is simple – it DOES NOT OBEY the fundamental law of investing, which is to buy low and sell high.
Yes, it is that freaking simple!
BUY LOW AND SELL HIGH.
Anything that does not conform to this law is garbage.
You buy under-priced assets and sell them when they’ve reached or surpassed their intrinsic value. This is how famous investors got rich and succeeded where their peers couldn’t. They didn’t “dollar cost average” (once again, if it’s so great, why don’t Wall Street hedge funds and money managers do it?) – they found good investments by carefully looking at balance sheets (or getting insider information, heh) and timed their entrances properly.