onsdag 26 april 2017

Market Timing vs. Dollar Cost Averaging

It's been a while since I wrote about my financial views, but now when markets around the globe are going strong and doomsday prophets shout that you should sell all now to avoid the inevitable down-turn I thought I'd write a little bit on how I think about market swinging up and down over time.
As with all other posts on this blog, the time frame of my investments is long 15+ years. If you need your money for things in the near future, you may need to follow another plan.

So, what is market timing?

Market timing is the ability to foresee a market swinging up or down and buying or selling accordingly to maximize the profits. Sounds good right? To be able to sell just before a market fall and then buy again at the lowest. This is the movie and Wall Street version of how the stock-market works, the ideal that many stock-brokers and money managers strive to do. And from time to time they get it right and they are the golden child, investors pour more money on them. The thing is that it is hard to time the market continuously, the pressure added if you did it once plays along but also the fact that it is not possible to foresee the future.

What is dollar cost averaging

Dollar cost averaging is the act of buying shares over a period of time, to prevent investing a large lump sum at the once and then seeing it go to nothing as the market crashed. Instead, you buy at the highest point (if the same crash scenario) with say a fifth of the total investment, and then continue to buy once each time period, say a month, until the money is spent.
In the case of a crashing market, the price per share is lower each time resulting in more shares bought for the same amount of money. So in the end you end up with more shares then if you bought them at once and then saw the market crash.
But the same goes the other way as well, you buy at the lowest and you would receive less shares then if you invested it all at the lowest point.
The idea is, that if you are a long term investor you do not care about the volatility of the market and just continue to buy in ups and downs. When the market goes down, you get more shares, when the market goes up you get less shares.. In the long run it evens out.
For me, I do not have a lump sum to spend so my monthly investment is basically a continuous dollar cost averaging scheme.

Numbers on a single share.

After reading the Forbes article Busting The Myth Of Market Timing, I decided to try to map the data myself based on a Swedish bank (SEB, or Skandinaviska Enskilda Banken AB) looking back a 10 year period.
2007-04-25 – 2017-04-25
The starting point is at the middle of a down turn, i.e. share prices are dropping.

Say that you have 1000 to buy with each month and continue buying for 10 years.
So when the share hits rock bottom at 18 SEK, you buy 54 shares as the share is on sale.
At the end of the 10 year period, you have received 1253 shares.

So how to simulate thinking like a market timer? As the share is dropping at the beginning of the scenario, lets think that you try to look at signs for things to change, criteria will be 2 months of gains until you enter and 2 months of dropping price and you leave. Otherwise you hold. (don't know if this is accurate but just bear with me)
End result, 954 shares... 299 shares less then the buy buy and buy more approach.

In reality
  • Each share pays out dividend.. 
  • Each transaction costs money
  • You pay taxes when you sell for profit (at least in Sweden)
  • Change is transferred to the next month, 
  • you receive a bigger paycheck and can invest more or do something actively to increase the amount spent each month
All this leaving you with a lot more shares then the example and even less shares if you market time. This is just one example, that happens to reflect my point of view but there is a lot of research done in this area and gurus like Warren Buffet think that market timing is a hoax.

But don't trust me, do your own research and find out more yourself. In the end, knowledge leads to better decisions. : )

Until next time: Work to Live, Don’t Live to Work

Disclaimer. I am in no way an expert on capital management or investing. On this blog I only wish to share my findings, ideas and comments on current events and fields that interest me. I hope that my thoughts can entertain you. I expect that everyone reading take their time and do their own research before acting on anything read on this blog. Investing is not for everyone. E&OE.

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