Is this the right time to invest? | Print |  E-mail
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Written by Richard Buck   
Monday, 28 April 2008

We hear the question quite often from clients and other investors. “Is this a good time to get into the market?” You might think any good financial advisor could answer that question without breaking a sweat. But the question isn’t as simple as it might seem.

For this article we interviewed Laura Wood and Paresh Kamdar, two Merriman Berkman Next financial advisors. They deal with variations of this question all the time. One thing they stressed is that there is no single answer that’s right for everybody. A solution that works well for most people might not apply to you because of your circumstances and your emotions.

FundAdvice.com: How and when do people typically ask this question?

Paresh: They may want to get into the market but they want to do it in a smart way, with the best strategy. They want to take advantage of good prices after the market is down and yet they don’t want to jump in when there’s so much bad news.

Laura: Some people have been in cash or CDs for a few years. Others are already fully exposed to the market and want to achieve better diversification.

Paresh: If I’m talking to somebody who is nervous and hesitant to move a chunk of money into the market all at once, I often relate a story about somebody who was in a similar position and decided to do dollar-cost averaging by automatically investing a fixed number of dollars every month no matter what the market was doing.

FundAdvice.com: Since we cannot know the market’s future, it seems that this question is really about managing the risk of the unknown.

Paresh: A lot of people think they hire us because we know what the market is going to do. We don’t, and that is the most important part of this equation.

Laura: That’s right. One year from now I can tell you the best move you could have  made today. But I can’t tell you that now. I ask them to think about what would make them more upset next year: Losing 10 percent of their account value in a down market or being in cash when other investors were making 20 percent in a very good market.

Paresh: That is an important point. Psychologists have found that the pain of losing $1 is greater than the satisfaction of making $2.

Laura: Dollar-cost averaging comes up when investors are nervous about the market, in times like we’ve been seeing this year. When somebody is already fully invested and moving to a better strategy, then dollar-cost averaging could even be counter-productive if it meant the investor sold at one price and bought back into the market at higher prices later.

It’s important to note that the diversified portfolios we offer usually have a lot less volatility than “the market” that is in the news all the time. In a globally diversified 60/40 portfolio, you are exposed only 30 percent to U.S. equities. And only a small part of that is in large-cap U.S. growth stocks that make the news. So the portfolio will not go up and down as much as many people might expect.

Actually, buying all these asset classes means that on any given day you are probably buying something that is priced high and something else that’s priced low, and they may offset one another. If you have a properly diversified portfolio, when you look back in five years or more from now, it will probably not make much difference whether you invested a lump sum or spread it out over several weeks or months.

Paresh: That’s true, but it still may be uncomfortable. Psychologically, investing all at once can seem like a pretty important event. I have found that people who have their money in cash tend to be very attached to the amount that they have. That is their benchmark. And if they are already invested in equities, they are attached to the high-water mark of their portfolio value.

FundAdvice.com:  Yes. My own portfolio is worth less now than it was last fall. Part of my mind believes that last fall’s high point is what my portfolio “really” is worth, even though it’s gone down.

According to the figures we present in our workshops, an all-equity globally diversified portfolio would have lost money in only seven of the most recent 38 calendar years. That portfolio gained in each of the other 31 years. If you picked one of those years at random, you would have been four times as likely to gain as to lose. So you can make a case for being in the market instead of using dollar-cost averaging.

Paresh: What you have just described is what we call an opportunity cost. You give up the opportunity for potential gains when your money is in cash. And yet dollar-cost averaging is very popular. I think it’s very effective insurance to protect you from putting all your money into the market at the wrong time. If it makes it possible for somebody to start investing or to begin doing a rollover into the proper diversified strategy, that is a good thing.

Laura: Rarely do I have somebody come to me and say they regret doing dollar-cost averaging. Sometimes I hear people say they wish they had averaged into the market. And yet this isn’t necessarily an easy strategy for investors. Some people will set up dollar-cost averaging and then second-guess it depending on how the market is moving. I tell them that if we set this up, we are not going to re-evaluate it every week and cancel it or change it because we had a good day or a bad day in the market. That reduces their peace of mind and produces stress instead of taking it away. It has to be on automatic pilot.

Paresh: I agree. It is important to make it automatic and mechanical. That way you can carry out a good long-term plan regardless of how you feel or what you think at any given moment. Many times, your emotions will make you want to do the wrong thing.

Laura: When my clients start with dollar-cost averaging, I tell them: When the market is going up, I want you to focus on the fact that your account statement is getting better and better every month. When the market is going down, I want you to focus on the fact that you are buying stocks at better prices and getting a better deal.

 Paresh: Some people are reluctant to do dollar-cost averaging unless they know exactly the right time to start it. I tell them that in 15 years in the business, the largest accounts I have seen are those in 401(k)s. The reason is that those people put money in automatically every time they got a paycheck without caring about the prices. They just kept doing it and let their money work for them month after month and year after year.