The risks of market timing and how to avoid temptations
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As an investor, you may be tempted to try to predict when to buy and sell stock. But we're here to tell you why to avoid market timing, and instead, offer tips on how to invest during a downturn.
If you’re a first-time investor, it can be especially rattling when there’s a slip in the stock market performance. Watching your money go up and down like a rollercoaster can make anyone queasy and frantically start searching for secret strategies to minimize losses or “beat the market.” It can be tempting to take the “market timing strategy” — whereby you try to predict the best times to be in the stock market and when to get out. But we’re here to tell you that the market timing strategy is a mistake and instead share some tips on how to successfully invest during a market downturn.
What is market timing?
When you start investing, your knee-jerk reaction may be to try to predict the best times to buy and sell stock. For instance, during a downturn, you avoid contributing new money to your portfolio until the market “bottoms out” or starts moving upward in a positive direction again. Or if you believe your stock value is about to go down, you may sell off your equities and change to a more conservatively allocated portfolio. This is called market timing, and it’s an approach that focuses on “beating the market.”
Why avoid the market timing strategy
Trying to beat the market is not a good idea. Market timing is next to impossible: no one – not even experts – can predict what will happen with the stock market. Even billionaire businessman Warren Buffet cautions against the market timing strategy, instead advising investors to make regular contributions regardless of what the stock market is doing.
The problem with the market timing strategy is that humans are very bad at it. You don’t know where the bottom will be and trying to predict it requires a crystal ball. On the other hand, it’s also extremely difficult to forecast market upticks, and if you sell your stock, you might miss a big gain because you were so focused on staying out of the market until the so-called danger had passed.
So what should you do instead of market timing? First of all, stay calm and carry on. Stock market downturns are normal, happening many times in the past and are bound to occur many more times in the future. Your best bet is to “buy and hold” while the market goes through its cycles.
Whatever you do, don’t sell your investments and convert them to cash with the foolish plan to rebuy later when the market stabilizes. This strategy is called “panic selling,” and while it might be comforting to cash in during a downturn, experts claim you’ll end up worse off than if you’d stayed the course. For instance, Bank of America Merrill Lynch found that investors that buy-and-hold outperform panic sellers every decade back to 1960.
If you’re having a hard time fighting the desire to convert your investments to cash, remember that bear markets don’t last as long as bull markets. If you stay the course, most bear markets resolve in about 18 months. The pain of investment losses will be over soon – so fight the urge to tinker with your investments. An easy solution? Set up automatic contributions, either through a robo-advisor or discount brokerage. By making it automatic, you’ll avoid the temptation to hold off investing.
Investing for the long-run
Does seeing your money dwindle during a downturn trigger anxiety? Relax: if you’re a millennial saving for retirement, you won’t need to access your investments for a long time. You’ve got oodles of time (decades even) to recover any money lost during a market downturn. Over the next 30 years, your investments will fluctuate – and constantly changing your investment strategy will not get you further ahead in the long run.
However, if you need your money sooner, carefully consider whether the risk tolerance of your portfolio reflects your goals appropriately. If you need the money you’ve invested within five years, moving it to a high-interest savings account or GIC will ensure it is there when you need it.
Generally speaking, the longer your investment horizon, the more aggressive you can afford to be with your investments. This is because your portfolio will have more time to recover from a market correction.
Stick to your strategy
Your portfolio is based on your long-term goals, not the whims of the market. Using a robo-advisor like Wealthsimple or an online broker like Questrade, your portfolio’s asset allocation is based on:
- Your money goals
- Your investing horizon
- Your assets and debts
- Your risk tolerance.
If you’re frustrated with your portfolio’s performance, remember that you chose your portfolio based on your long-term goals. Yes, there will be periods where your investments aren’t growing according to plan, but over the long term, the asset allocation you chose will get you where you want to go. Just stick to the plan you made when the markets weren’t in flux and you’ll be fine.
Can’t cope? Choose a robo-advisor
As we’ve emphasized, the best way to invest your money during a market downturn is to stay the course. If you’re having trouble doing this yourself, choose a robo advisor to automate your investments and help you keep your hot little hands off your portfolio. Here’s what to look for in a good robo advisor:
Setting up automatic contributions to your investment account is a surefire way to avoid the temptation to time the market. Making small regular deposits is an excellent strategy to handle the dips and waves of the market, and ensures that you’re investing your money consistently, instead of just when you think it’s “best.”
For example, Wealthsimple recently introduced Overflow – a new program that helps Wealthsimple customers maximize their investment contributions. Once activated, Wealthsimple takes a set amount of excess funds from your bank account and moves them into your Wealthsimple investing account on a monthly basis. It’s a great way to top up your investments without having to do any work.
When markets are in flux, your portfolio’s asset allocation can fall out of balance quickly, resulting in a lopsided portfolio. If you invest your money yourself in a discount brokerage, you’re responsible for rebalancing. Robo advisors, however, will take care of automatically rebalancing your portfolio and ensuring your assets reflect your target asset allocation. Most robo advisors perform this service behind the scenes, and you don’t need to lift a finger.
Portfolios to suit your risk tolerance
Whether you’re a new investor saving for retirement or a seasoned pro whose golden years are around the corner, it’s essential that you choose a portfolio that accurately reflects your risk tolerance. Choosing the right portfolio is especially important when markets are in a downturn because if you’ve misjudged your risk tolerance, you’ll find the drop in your portfolio hard to handle. Luckily, most robo advisors offer at least five portfolios to choose from, but some offer as little as three and as many as 70.
If your portfolio performed poorly, it’s important to minimize what you’re paying in fees. If you’re invested in mutual funds in Canada, you could be paying fees as high as 2.5%. Those fees come off the value of your portfolio, regardless of whether or not you had a positive return. Robo advisors charge less, usually between 0.20% – 0.50%. While those few percentage points don’t seem like much, over time they can add up to hundreds of thousands of dollars in lost returns.
The best robo-advisors in Canada
|Robo-advisor||Best for||Promo||More info|
|Wealthsimple||Best overall||Get a $25 bonus when you open and fund your first Wealthsimple Invest account (min. $500 initial deposit)!||Read Review|
|RBC InvestEase||Big bank robo-advisor||N/A||Read Review|
|Questwealth Portfolios||Competitive fees||Get your first $10,000 managed free for a year||Read Review|
|CI Direct Investing(Formerly WealthBar)||Access to private investment portfolios||N/A||N/A|
|ModernAdvisor||Expert-assembled portfolio||N/A||Read Review|
The bottom line
The bottom line? The best way to invest your money in a market downturn is to stay the course. This isn’t exciting advice, but if you’re following a passive index-based investing strategy like the Canadian Couch Potato strategy, you’ll come out on the other side (relatively) unscathed.