Topic: Daily Advice

Stock market strategy: Avoid market timing. Follow this stock picking advice

July 14, 2016|by Pat McKeough

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Being a fair-weather investor is not a sound stock market strategy.

Over the years, we’ve met a number of investors who favour a stock market strategy of buying stocks only when economic and financial conditions seem good, if not ideal. If these investors hear talk of rising oil prices or interest rates, for example, they are inclined to stay out of the market, or get out if they’re in.

In contrast, when they think conditions are ripe, these same investors are relatively casual about what they buy. They readily accept recommendations from brokers, or they buy stocks that are spotlighted by the media or public-relations firms. They give dicey insiders the benefit of the doubt.

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You might say these investors’ stock market strategy is highly sensitive to stock market timing risk, but relatively insensitive to investment-quality risk. This is pretty much the opposite of our approach to investing.

How stock market timing can compound your losses

If you compound the error by selling whenever you think market risk has gone up, then you’re going to sell near market lows.

Up to a point, you might say we give the market outlook the benefit of the doubt. Stock market investors have to accept the constant risk that unforeseen events—unrest in the Middle East, a terrorist attack or even a spike in interest rates—may come at any time. You can’t predict when these events will take place. For that matter, you have no way to tell if an unpleasant surprise is a solitary event or the first in a series.

Mind you, we always have an opinion on the market outlook and we routinely share that opinion in our publications, including our flagship newsletter, The Successful Investor. Our market views do have some impact on our recommendations. But our advice relies much more on investment quality and our five-sector approach to diversification.

Stock market strategy: cut risk by focusing on investment quality

Opinions always differ about what constitutes a high-quality investment. However, if you invest mainly in well-established, dividend-paying companies, you’ll find that your investment or market timing mistakes rarely lead to serious or permanent losses. If your stock market strategy focuses on spreading your money out across most if not all of the five main economic sectors (Manufacturing & Industry; Resources; Consumer; Finance; and Utilities), you’ll cut your vulnerability to market risk all the more.

In contrast, your market timing skills will always be crude and unreliable. They will never protect you from the risks of investing in companies with flawed business plans.

Moreover, even the best market-timing skills are useless when it comes to protecting you from untrustworthy insiders. If we have reason to doubt the integrity of a company’s insiders, we stay out, no matter how tempting it seems. There is no limit to the ways in which unscrupulous insiders can cheat you.

Those are the risks we focus on and attempt to avoid. The damage they can do to your finances makes political turmoil in the Middle East, interest-rate increases and general market risk seem tame by comparison.

Dollar cost averaging is a great stock market strategy

Long-term studies show that the stock market as a whole generally produces total pre-tax annual returns of 8% to 10%, or around 6% after inflation. Over periods of a few years or less, the return is far more variable and always uncertain. The surest way around this uncertainty is to start practicing dollar-cost averaging as early as possible, and invest regularly over the course of your working years. Then you can sell gradually in retirement.

In fact, if you invest a fixed sum at regular intervals throughout your working years, perhaps increasing that sum from time to time as your income rises, you can largely forget about market trends. That’s because you’ll automatically buy more shares when prices are low and fewer when they are high, and you will benefit from the long-term rising trend in the market.

What’s your stock market strategy? Leave a comment with your thoughts.