Back in December I wrote about a market timing strategy that has shown to work over a limited sample size. It had shown to provide a little better return than the overall market with significantly less downside risk. I thought it would be “good timing” to update the results of this strategy and provide more data on it after we just experienced a significant decline in global equities during the 1st quarter.
As a reminder the buy and hold portfolio in this analysis simply buys and holds the Vanguard 500 Index (VFINX) for the entire period, while the timing model also starts by owning the 500 index. The timing model moves the entire balance into the Vanguard Short-Term Treasury Fund (VFISX) every time the 500 index falls below its trailing 10 month average price (200 day moving average).
*These results are hypothetical and have the benefit of hindsight bias. They do not account for transaction fees or taxes. Past performance does not predict future results. Data was pulled from www.portfoliovisualizer.com.
It appears the strategy done its job in 2020 so far, by moving into the short-term treasury fund by the start of March and avoiding a further decline. This helps make up a little for the multiple false signals that were generated in 2019 which caused the market timing model to underperform the buy and hold portfolio by over 20% for the calendar year.
A statistic that is commonly thrown out by the financial community is that if you miss just 10 or 15 of the best days in the market over a long term horizon, it drastically reduces your rate of return. This is true. Data from Dimensional Fund Advisors shows that from 1990 – 2019 the S&P 500 Index earned 9.96% annualized, but missing the 15 best days over that time period would have reduced your annualized return to 6.56%, and it drops to 4.99% if you miss the 25 best days.
Of course, a skeptic would ask “what if I miss the 15 worst days?”. I suspect the odds are low that you’ll happen to miss just the best 15 days or worst 15 days, but this 2011 paper from Meb Faber shows that from 09/1928 – 2010 about 76% of the worst days in the market and 67% of the best days happen after the market is already below its 200 day moving average. So, what if you missed both the best and worst days? Let’s look at the data:
(Note: Number of 1% days is referring days that were either the best or worst 1% of all days, same for the number of 0.1% days)
Faber shows that during this time frame the annualized return of US stocks was 4.86% (price only, does not account for dividends). The interesting part is that the volatility is greatly enhanced, and the return is greatly reduced while the market is below the 200 day simple moving average.
Now is this just a random fluke? Faber admits that the intent of this strategy is not the outperform the market, but to reduce the chances of an extremely bad outcome. Interestingly enough, he also looked at stock markets in other countries to see if this strategy would work there:
I’ve never considered market timing an “investment” strategy, actually I have a lot of disdain for market timers. Although if I were to time the market, I would use a strategy like the one Meb Faber has detailed in his paper above. While the summary statistics from this strategy of course look appealing, there is never a free lunch. You will still likely go through very long periods of underperformance in such a strategy, and during those periods you will be questioning the validity of it. The false signals can take psychological tolls on investors just as market declines can. You definitely do not want an investment strategy that you are constantly questioning.
A viable question on a strategy like this is “will it continue to work?”. I suppose a case can be made that as long as humans are humans, it has a good chance.
When I think about investment strategy for my clients and myself, I try to adhere to a philosophy and perspective that I can defend until the death. Buying passive funds that screen for low priced smaller companies, that exhibit profitability, is a strategy that I am confident will continue to be effective.
BUT, if you are going to be a market timer and understand the tradeoffs of such an approach, a rules-based systematized way of doing it is the only way I would implement. Any time you can remove emotions and judgment decisions from the equation, I consider that an improvement. You don’t want to be sitting around, scratching your chin, reading about the coronavirus, and wondering if you should buy or sell today.
While we financial advisors tend to be a bit dogmatic in our advice in many cases, there are actually many strategies that work to grow and protect wealth.
This article is for informational purposes only and is not a recommendation of Meredith Wealth Planning or Mark Meredith, CFP®. Past performance may not be indicative of future results and may have been impacted by events and economic conditions that will not prevail in the future. Therefore, it should not be assumed that future performance of any specific security, investment product or investment strategy referenced in the Article, either directly or indirectly, will be profitable or equal to the corresponding indicated performance level(s). No portion of the Article shall be construed as a solicitation to buy or sell any specific security or investment product or to engage in any particular investment strategy. Any reference to a market index is included for illustrative purposes only, as it is not possible to directly invest in an index. Indices are unmanaged, hypothetical vehicles that serve as market indicators and do not account for the deduction of management fees or transaction costs generally associated with investable products, which otherwise have the effect of reducing the performance of an actual investment portfolio.
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