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Sunday, December 28, 2008

"Time in" vs. "Timing" the market

This is one of those investment debates that has been waged through the years, with no sign of a resolution in sight. With strong opinions on either side, it is quite likely that the controversy will endure for a long time.

The dilemma arises because of the way most experts and analysts define 'timing' - they mean selling out your equity portfolio completely at market tops, and buying the same portfolio back at market bottoms.

Common sense - which is not so common among the majority of investors - dictates that such a plan is doomed to failure. Why? Because consistently deciding when a market has reached a top or bottom over several economic and stock market cycles is pretty nigh impossible.

The stock market moves on its own logic, reflecting the collective sentiments of various market participants who have differing agenda. The hedge funds are in it for the short term (i.e. less than one year). Some of the Foreign Institutional Investors (FIIs) may invest for a longer term of 3-5 years. Pension funds tend to be real long term investors who stay in for 10 years or more.

As an individual investor it will be quite futile to try and outguess what these big boys are up to at any point of time. Chances are that they are better informed and have more research and financial resources. Therefore they can enter and leave the market in droves - driving up or smashing down prices before you can say 'Jack Robinson'.

Research has proven that those who stay invested for the long term perform much better than those who try to exit and enter the stock market frequently. No wonder most fund managers say that 'time in the market' is preferable to 'timing the market'.

While I can not disagree with such strong logic, backed by academic research, my investment experience has been otherwise. It arises from the basic definition of market timing.

For long term investment success it is imperative that you try and time the entry into and exit from individual stocks. But do not try to exit from your entire portfolio or try to buy the whole portfolio back.

If you've read my earlier post (Dec 1: Market cycles and Sectors), you will know that different sectors - and therefore, stocks from those sectors - get prominence depending on the state of the economic and market cycles.

Like now, when the Sensex is trying to find a bottom, FMCG stocks are hitting their 52 week highs whereas metal stocks are hitting their 52 week lows. So this is a good time to exit from FMCG stocks and enter metal stocks. (You don't have to sell your entire holding in a sector. Partial profit booking works pretty well.)

Now, experts and fund managers will tell you that FMCG is a good defensive sector to enter in a bear market and metals will face a lot of pain over the next couple of years. They will be quite correct from the short term view of the market. But a small investor with a long term outlook has to play contrarian. That is the only way to 'beat' the market.

While the 'time in' vs. 'timing' debate rages, my solution to the controversy is to replace the 'vs.' with 'and'; i.e. stay invested for the long term but time the entry into and exit from individual stocks.

In a future post, I will discuss about a technical indicator that helps lay investors to become master timers.

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