"Timing" indexed investments

[Free-quent Flyer]

This is something I've been thinking about for a while now and thought I'd see if I could get a discussion going.

I don't believe in stock picking or market timing. I think it decreases returns for at least 50% of people trying to do it (closer to 100% over the long term), and I also think it's impossible to know in advance whether you're in the losing or winning half of the pool. In other words, it's gambling, which is fun, but is also different from saving/investing.

But there's a related issue, which is that even if you are wisely saving in a low-cost target retirement fund, if you're making deposits at random (I see a lot of this on the Forum, "I just got a bonus/inheritance/severance, what do I do with it?") you're also inadvertently timing the market.

That's exactly what I did a few months ago when doing my taxes. I calculated the IRA contribution that would yield the maximum Retirement Contribution Tax Credit, then deposited that amount in my Vanguard account, buying additional shares of the 2045 Target Retirement Date fund my IRA is invested in.

The balance seems to have grown in the intervening months (don't check your retirement account balances every day), but I also could have been buying at the very top of the market, because I was buying essentially at random (the tax filing cycle is unrelated to the business cycle).

The obvious and extremely common solution to this problem is to have contributions automatically deducted from your paycheck. Except since it's (for most people, most of the time) not possible to have IRA contributions deducted directly from your paycheck, people come up with kludges. For example, if you're always paid on the last day of the month, you can have Vanguard make an automatic withdrawal from your checking account on the first day of the month. By then your paycheck will have cleared, and instead of contributing once in April of every year, you contribute 12 times distributed evenly throughout the year. That means you have 12 chances to buy at the top of the market and 12 chances to buy at the bottom. Over a working career, that will largely smooth your contributions out over the business cycle.

But why stop there? Wouldn't it be better to make a contribution every 2 weeks, doubling your number of contributions from 12 to 24 and making your contributions even smoother over the business cycle?

Obviously at some point there’s a balance between the advantages of smoothing your contributions and the attention demands that frequent manual contributions make. But I also think there really are advantages to smoothing your contributions! And after all, as travel hackers there are a lot of things we do that place attention demands on us that civilians don’t face.

So I think it’s worth making a compromise between those advantages and attention demands. There are lots of forms this could take: you could make a single monthly or even annual IRA contribution, but instead of buying investments immediately, make the contribution to a money market account, then make four purchases throughout each month. To keep yourself from slipping into the habit of trying to time the market, you could place a buy order every Sunday night, while the markets are closed, to help ensure your investments are as passive as possible.

Ultimately that’s the point I think is important: it’s all well and good for your mutual funds and ETF’s to be passive once you’ve purchased them, but it’s also important to have as much passivity as possible in the timing of your purchases, so you don’t slip into the always-tempting habit of trying to time the market — you’ll almost certainly fail.

 

[Matt]

I think the underlying thought here is to look at dollar cost averaging vs lump sum investing. I explored that somewhat here, where a study by vanguard showed that lum sum tended to outperform. https://saverocity.com/forum/threads/dollar-cost-averaging-the-basics-the-advanced-and-where-it-breaks-down.617/

The premise for the superiority of lump sum investing is that if you intentionally hold off funding and instead drip money into the account you are losing out on opportunity cost of the growth of that money. Of course, this assumes you are shoving it under the bed in the interim.

Timing does matter. Sadly, most studies can manipulate the timing to show how it does not... I try to look at the idea of investment diversification or savings to income in order to be able to repair a negative market event should you be 'all in'.

 

[Free-quent Flyer]

I was actually going to address that! Decided it was best to just lay out the general idea first.

So there are a couple issues here, first it really, really depends on your liquidity. The reason people contribute from their paychecks is that most people – even people who are meticulously and virtuously saving! — live paycheck to paycheck. That is to say, even good middle class earners who "pay themselves first" by locking up a certain amount of their income in savings vehicles, then go on to spend the entire remaining amount.

That being the case, the lump sum versus drip debate narrows down to extremely small time increments. Under almost all 20th century time horizons you'd be better off over a decade if you could contribute the decade's IRA contributions on January 1 of year 1. But if we're talking about a year's contributions, I think the advantages of buying in at the average of the year's stock prices rather than the price on January 1 would over time smooth investment returns.

I haven't dug into that Vanguard study yet, but strictly looking at "outperformance" versus "underperformance" isn't exactly the point of what I'm saying. The fact that 66% of theoretical portfolios outperformed and 34% underperformed isn't as relevant as knowing that dollar cost averaging (theoretically) guarantees that when you underperform, you underperform by as little as possible. Lump summing it means that the 34% of the time that you underperform, you underperform by a lot (throw everything in at the very top of the market in 2008, only recover the value of your investments in 2014/2015).

The folks at Vanguard are smart so they may have controlled for that, and I don't want to put the theoretical horse before the results buggy. But I do think "underperformance" isn't the exact right metric to judge what I'm describing.

 

[Free-quent Flyer]

It's market correction day! I assume many people here are moving cash into stocks to take advantage of today's drop in domestic stock prices. Hopefully they're moving into funds representing broad swaths of the stock market instead of picking individual stocks!

This is, of course, market timing, but it's the most defensible form of market timing: if you were willing to buy VTI at 108.84 on July 31, by definition you should be willing to buy VTI (the same product!) at 102.23 today. And if you're not willing to buy it at 102.23 today, you shouldn't have been willing to buy it at 108.84 on July 31. That is to say, a passive investing strategy should be agnostic about market movements, but need not be agnostic about prices: drops in prices are bad for sellers and good for buyers; increases in prices are good for sellers and bad for buyers.

So that's what I've been thinking about lately: is there a way to time purchases of passive, indexed investments, meant to be held long-term, that still allows the investor to take advantage of market moves?

To be clear, I don't think any of these strategies is more likely to produce excess longterm returns over simply contributing a steady amount out of each paycheck; it's just a fun thought experiment. With that said, here are a few ideas. For these examples I'll use the $5,500 annual IRA contribution limit, and assume that the investor has the $5,500 in cash available immediately. Here are some strictly passive investment strategies:

• Make a $5,500 purchase on January 1 of each year, against the current year's contribution limit. This is the "lump sum" investing Matt mentioned above. It means your entire IRA contribution is immediately invested and eligible to take advantage of any market gains each year.
• Make a $5,500 purchase on April 15 (or your filing deadline) of each year against the previous year's contribution limit. This sacrifices 15.5 months of potential market gains, but gives you 15.5 months of access to the cash.
• Divide the $5,500 into 12, 15, 24, or 30 equal contributions and make them each month on the same day (a traditional "paycheck" model of contributions). 12 and 24 contributions are monthly and biweekly on an annual basis, 15 and 30 are monthly and biweekly if you split contributions all the way up to your tax filing deadline. Those would be roughly $458, $229, $366 and $183 contributions (although note that you'll have to make 2 $366 contributions or 4 $183 contributions for the first 3 months of each year, since you'll be overlapping with the following year's contribution limits. This is basically strict dollar cost averaging. You'll end up buying into the market at its monthly and yearly average price.

Ok, but what if we don't want strict dollar cost averaging? What if we want to take advantage of market price drops, and don't want to wait until our next scheduled contribution in case the price recovers before then? Here are two strategies that you might use to convince yourself you're "buying low:"

• Spread contributions throughout the year, but make them based on price triggers. One version of this would be to say "I will make a $458 contribution on the first day of each month where I see a price drop of 2% or more, or the last day of the month, whichever comes first."
• Another version is to use price triggers to buy investments, but without any pretense of spreading contributions throughout the year. You could say, "I will make a $458 contribution on the first 12 days of the year where I see a price drop of 2% or more."

At the end of the day, these are all varieties of market timing, and they're all unlikely to result in returns that exceed a truly passive investment approach.

Having said that, I made a $458 contribution today. It might be the beginning of a long bear market, it may be a one day fluke, but either way it got me off my ass and contributing to my IRA!

 

[Matt]

IFTTT

Personally I pushed more money in 'some days ago' and I'm pushing more money in right now. Ironically, it just happened to be good (or maybe bad) timing. I'm not reacting to the market per se, my decisions were both forced by other pressures. However, based on the movement, I'm certainly excited that my planned move in is synchronized with the downturn.

I looked at the chart today, and while it feels painful, the 'correction' is still a minor event.

The only issue I have with the timing model is that it would need to be implemented with some more sophisticated approach... IE you couldn't just trailing stop it, because you'd often miss the timing. Maybe a value/PAR approach... but still overall not something I'd jump on.

I'm trying to keep it simple myself:

1. How much do I need when I can't earn anymore?
2. How much of that can I push in via fixed rates (earnings)
3. How much does that then require me to earn from the market.

I feel that timing/DCA/whopping farm bets on oil futures etc lack the above vision and perhaps come at it with an overall sense of vagueness. I'm focused on clarity of the goal, because once you know what you might need, you know whether the timing tricks or other clever ideas are needed or not.

If they are needed, you're likely up shit creek already. If they aren't needed, don't sweat it...

 

[Hanaleiradio]

I'm trying to keep it simple myself:

1. How much do I need when I can't earn anymore?
2. How much of that can I push in via fixed rates (earnings)
3. How much does that then require me to earn from the market.

I like keeping it simple, too. However, what has been the dilemma is that the second leg of your equation, which I assume is to be low risk, doesn't "push in" enough in the current low interest rate environment to minimize the need for earnings from the riskier third leg.

Agree that clarity of the goal is paramount, and very few focus on this. Being able to make a difference in life can often be achieved with limited financial resources. Plenty of folks learn the hard way that "money can't buy me love!" Lots of ways to make money and be contented without "investing" in the markets.

I've come to firmly believe that if one needs to, or is interested in dabbling in the third leg to garner the money they think they need to be fulfilled in life, then in the current financial era its become an obsessive-all-in,or, stay-home proposition. You have to spend the time and effort (which takes years!) to learn how to trade and time the equity and commodity markets with reasonable success, based on an analysis of global financial & economic trends AND a good understanding of technicals (or find a very good independent broker who does this). Or, if one is not interested in climbing the learning curve, then they should confine their "investments" to cash, bonds, land, Kiva like loans, or equity investments in local businesses that you really know, and stay OUT of the markets.

Financial markets and global economies are fundamentally different now than they were during the 55 years post WWII. The buy and hold, dollar cost averaging, dividend focused, index fund/ETF--every passive investment strategy that is peddled by Wall Street to the masses--were all developed and prospered in a different era--before globalization, international hot money, high frequency trading, hedge funds & private equity firms, sovereign nation funds, automated portfolio rebalancing, frequent black swans, a bifurcated & dysfunctional EU dominated by Germany , a paralyzed US political economy, the ascendency of China (whose leaders don't understand their limits in controlling financial markets) etc etc etc. What used to work won't work now. (And there are strong arguments that widely accepted Wall Street investment "truths" are merely myths . For example, Wall Street says that stocks always outperform bonds in the long run. And yet since the start of the greatest equity bull market in history in 1982, bonds have outperformed stocks!)

Although financial markets are very different, human psychology is not much changed. And good, time-tested technical analysis captures this in the short run. They currently show equities to be highly oversold. If one is not interested in world affairs and learning about global economics, one should at least learn technical trading if they are going to "invest" in the markets.

I covered all shorts at close today, and expect a dead cat bounce in the next 1-3 days. I won't go long, as nearly all the major trend indicators have now firmly reversed and are heading south to next major support level of around 1865 in the S&Ps. We could see 1820. With current volatility I could very well be wrong, and the dead cat could grow legs. But, I've already earned what I needed for the quarter, and I have other things to do for rest of the week that are far more rewarding than financial gain from trading.

 

[Matt]

I like keeping it simple, too. However, what has been the dilemma is that the second leg of your equation, which I assume is to be low risk, doesn't "push in" enough in the current low interest rate environment to minimize the need for earnings from the riskier third leg

Not fixed income like bonds, fixed income like salary.

IE: Calculate retirement needs, figure out the most I can set aside towards that, and use investments to bridge the gap. If the gap is too large, consider working longer, saving more, 'needing' less.