I wrote recently that I was preparing to ‘time the market’ by reducing my Stock positions drastically, fueled by my feeling that the market was too high, I think that it is artificially propped up at this time by government support through the Quantitative Easing programs in place. Of course many people disagreed with my approach since they spouted the age old wisdom that ‘you cannot time the market’.
There is some truth in that too, since it is impossible to know exactly when things will turn upwards, or downwards, but it is possible to understand the underlying value of a company, and an Index, and look at a myriad of indicators that could imply if things are currently trading above or below their fair market value.
However, without getting into to the steps required to analyze a stock, there is something more important underlying my decision to ‘time the market’ you see, I didn’t actually time the market, I just prepared to time the market. The distinction is that whilst nothing has changed noticeably in terms of the market value since I made my move (things dropped a bit, but nothing of real note) what has changed is my asset allocation, and more importantly my liquidity and marketability levels.
Previously, I was engaged in a very aggressive 95% stock portfolio, however, whilst Stocks are Marketable (in that they can be easily sold and bought) they are not Liquid assets, because whilst they can be ‘liquidated’ immediately, they cannot be liquidated whilst guaranteeing to preserve value. In other words if the market tumbled I could certainly sell them, but for cents on the dollar.
Now, I am sitting on some Stocks, and a lot of Cash (proportionally)and whilst the cash is losing money every day due to the impact of inflation, it is liquid, and able to go to work for me when I need it too. A reason why this is important to me is that I projected near term cash flow to be inadequate to protect a downward shift in the market. This is an important ratio to watch as a younger investor. Retirees naturally have this view on defensive strategies because they have lost access to salary, and the Time Value of Money is reduced by their life expectancy and need to spend it in the short term.
However, investors like myself in their 30’s can find themselves in unique positions, specifically after periods of tremendous growth, which is what we have experienced recently in the market. So much so that our asset allocations can be out of line with our income and cash flow. For example, take a guy called Barry who is 32 with a $100,000 salary and $200,000 in 401(k) back in 2009 – looking at the S&P500 from then at 676.53 to todays high of 1703.19 which is a gain of 252%. That $200,000 is now valued at $504,000 and his retirement projections have just changed considerably, since his Financial Plan should have factored in a stock market growth rate of between 6-8% per annum.
Furthermore, should the market drop by 50% (it can happen people) he is back down to $250,000. And, that unrealized loss of $254,000 is not repairable with a salary of $100,000.
It is this logic, with slightly different numbers, that led me to lock in a chunk of my profit. If Barry sold 50% of his stock position now, and the markets dropped by 50% he could buy back in easily, and dollar cost average his loss to repair that hit. Of course, the naysayers might claim the market would continue to rise, which is possible, but if Barry already is years ahead of the game by locking in his profits, then why would he want to gamble?
Timing the market is not possible, but make sure that your asset allocation in relation to your salary, savings and emergency fund is not so exposed that it cannot be repaired if things go wrong. And a good time to take a snapshot of your assets and investments in relation to your income and non market savings is right now!
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