If there’s one fact you have to accept about investing, it’s this: you will live through a stock market crash over your investment life. Probably more than one. And here’s another thing you better accept: don’t bother timing the market. It will come when it comes. Obsessing over market timing patterns and subtle clues will drive you crazier than those wacky finance guys on TV.
But! You also can’t be a toddler about it and pretend it doesn’t exist if it’s right in front of you. So if you’re an early retiree or financially savvy (as you probably are if you’re one of my readers,) you probably have LOTS of money in play. That means dealing with recessions properly is very important, and doing it wrong can give you more stress than a full-on toddler temper tantrum.
No one can really predict the market highs and lows. We can make assumptions, we can analyze past ones, but no one knows for sure. If someone could time the market, the highly paid fund managers would outperform the average, but they don’t. Tonnes of evidence suggests that getting it wrong is more likely than getting right.
So if timing the market is impossible, we should just ignore it, right?
Well, you could. But there’s a better method that results in beating the market consistently. Even better, this method:
- Is reproducible – no unicorn one-offs
- Is incredibly simple
- Follows rules so you can ignore your emotions.
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Here’s the “Market Timing” method:
ABAB = Always Be Adjusting Bonds.
Adjust what % bonds you keep in your portfolio based on market highs and lows. But the real kicker that helps you ignore your emotions and win out is that there are only two steps.
It’s a simple two step plan where you adjust your bond % as the market moves through its cycles. I’ve detailed my general routine in my strategic allocation post but I wanted to go through why I ended at a 70/30 stocks to bonds mix here and why this is so powerful.
Usually, people get more into bonds as they get closer to retirement to reduce the risk of losing everything if it’s a bad year for stocks. But there is also guarantee that your total returns will decrease which causes a risk of running out of money if you live too long.
So why guarantee a bad thing when you can avoid it all together?
“Timing the Market” TL;DR:
When markets are “high”, have extra bonds.
When they are “low”, have close to no bonds and don’t be conservative.
It sounds like timing the market, but it gives you generous wiggle room. You don’t have to hit the peaks – just be in the right ballpark. And how do you hit the ballparks? I’m sure you can figure it out with an occasional look at the market charts.
Let’s get a few facts out of the way.
- Timing the market perfectly is impossible. So we’re not going to bother. We’ll just try to optimize our rules for “I feel like I can predict the market collapse within a few years.”
- You are not special. (And neither am i.) None of us can call the next recession. Maybe you’ve done it once, but you can’t do it again. (At best, you’re one of those people who’s always predicting a recession, in which case it doesn’t count.
- Markets will still be awesome in the late stage, prior to explosion as people experience FOMO. So we don’t want to miss out on that. (See graphic below.)
- You will suffer from FOMO as well. That’s okay. Just follow the rules.
Here’s the proof baby
That said, I made a few simulations. Let’s say…
- You invest $100,000 over 20 years.
- There’s a recession every 6 years – with 32% market collapses
- Other than that the market is growing at 12% every year.
I could make all sorts of simulations, but that wouldn’t change my conclusion. This one’s close enough to real life.
Case 1 – You can time the market tops and bottoms within a year
Let’s say a year before the market top you go 100% into bonds and then a year after the market bottom you go back to 100% into stocks.
The blue line represents what your assets if it was just in the stock market
The red line represents your assets if you follow my allocations
The yellow line represents how much you have in bonds.
If you go 100% into bonds before the market top and then 100% into stocks after the market crash – you’ll have over $100,000 extra to your name after the three recessions.
Case 2 – You can’t really call it
On the other hand, if you can’t really call it, and make your money moves 3 years before or after each peak, you’re kind of screwing yourself. (That red line is wayyy too low.)
Case 3 – You can call the market tops and bottoms but not that well.
Heck. Say you can sort of call it, but not too well. Nobody’s perfect. In this case, I adjusted my bond allocation to just 30%, and my assets still come out ahead of the market average. 100% stock allocation would make sense too, but most people would say it’s too chaotic. Plus you’d be missing out on two major benefits of having bonds.
Bond Benefit 1: Your sanity.
Having a bit of money to re-allocate during a recession is good for your sanity. It makes you feel in control and that’s a powerful thing.
Plus if you are living off your investments it feels bad to sell stocks (to pay bills) during a recession. Selling bonds feels right. Plus I recommend you keep your extensive emergency fund in bonds to live off in a market fallout.
Bond Benefit 2: Calling bottoms
Calling a market top is impossible to do accurately time-wise. Bottoms though. They feel easier. Things move fast and you won’t buy in at the cheapest possible time, 100% guaranteed.
But you’ll be right within a few (very important) months. So if you rejig the numbers with some magically accurate market bottoms (where we re-allocate to 100%) you might end up doing very well. Plus it’s sanity saving to try 🙂
Case 4: You can call market bottoms really well.
In this case, we’re just okay at calling the market tops, but we’re dead on at calling market bottoms. If you don’t want to go 100% bonds, just go 30% and sell them right within a few months of the market bottom. Boom. Again, you’re at over $100K ahead.
How do you call time the market bottom?
I always feel very confident when stocks have dropped 30%+ that they are cheap. And I feel very confident that things are NOT cheap when I hear news about market records being set and my co-workers talking about how they are getting into the next big hyped investing thing.
That’s my 1 rule process:
- Live at 70/30% stock split so that you aren’t on a financial rollercoaster
- BUT: Know that 100% stocks get the best returns but you will be on a rollercoaster that will occasionally make you want to hurl.
- UNLESS: stocks are so cheap you can feel justified being at 100%, which you can temporarily live off.
What about timing market tops?
These are trickier because they sometimes go up up up up up with no end in sight. But in general, after things go up for a long time – they drop down.
Reasonably, no one knows when markets will collapse. Just look at the 2009 crash. If you read The Big Short, piles of people thought that the market was rotten but Lehman Brothers and co. lived on top of a pile of rotten investments for many years before there was a collapse.
Even once everything is broken it can take years to see the effect. Momentum is really powerful…just look at BitCoin.
The normal human reaction when it comes to market timing
The normal human reaction is to over-research and try to use your special mental capabilities to outsmart simple rules. But I disagree.
- You aren’t special as discussed. No one is terribly good at calling highs, there is too much emotion, news and momentum tied into market prices to predict anything accurately.
- Most people get excited when they hear about market records being set and FOMO sets in. Then they swap to 100% equities when everything is super expensive. The exact opposite of what we want.
If we can use these rules to buck the trend and programmatically go to 70% equities when markets get frothy then we’ve made a huge win for both your sanity and your investment returns.
What am I up to?
These days I am quite certain stock markets (and housing markets…and crypto markets) are insanely highly priced.
It makes sense. When people like me with excess money get more by having cash payouts or reduced mortgage payments we stuff more into investments.
But I have no idea WHEN they will fall. Some day.
I also think things could keep skyrocketing for a few more years so I’m still “in the game.”
So I have moved into 30% bonds (and any lines of credit are empty in case I need them for something smart mid-recession). I’m confident I can re-allocate my money when the time comes and I’m confident that what I’m invested in (indexes) won’t go bankrupt.
I sleep like a baby and I don’t keep up with any market news.
