When a client has a liquidity event, for example, they have a big decision to make: invest all the proceeds immediately, pursue a regularly-scheduled calendar method or take an opportunistic approach based on market fluctuations. Each option carries certain risks and benefits, and no one approach is the right one for everyone, Renz explains.     

Family Wealth Report does not necessarily agree with all of the points made but is delighted to publish them and welcomes reader responses.

Market timing has been discussed and debated for decades. Successful market timing requires knowing when to get in and when to get out of the investment markets. Investors and traders have long searched for a sure-proof methodology of knowing when to invest, using everything from quantitative analysis, technical analysis or other non-traditional methods in an attempt to “buy at the bottom and sell at the top.” Some investors have claimed victory with their methodology, but often cannot repeat the process consistently in large measure, belying their claims.

Market timing can be divided into two types: intentional timing and unintentional timing. Intentional timing is based on quantitative and technical analytics, such as determining when certain asset classes are attractive or not, then making investments accordingly. Unintentional timing is behavioral – rooted in fear or greed. There is a term for this called “hindsight bias,” the belief that one should have known the outcome when looking back at an event. But the reality is that if the human mind had the ability to predict the future with clarity, events like the market crash of 2008 would not have happened.

The truth is that while we can observe market conditions and be wary of corrections, market timing is unpredictable and subject to many factors beyond our control.

So how do we think about market timing differently? Instead of thinking about timing solely as buying at the bottom and selling at the top, investors should ask, “When do I take my cash and use it to buy investments?” This is a question that requires a lot of consideration from multiple perspectives and will be different for every client.

Certainly, no advisor is going to recommend – and no client is going to want to keep – all of his or her capital in cash, making investments and banks necessary to both protect and grow wealth. But some banks and brokerage firms will encourage clients to invest all of their capital immediately. The bottom line is that the more capital a bank or firm has the more fees they earn regardless of the client’s best interest. Factor a liquidity event into the equation and the decision of when, how much and where to invest cash becomes overwhelming.

There are three basic approaches to the question, “When do I take my cash and use it to buy investments?” They are:

1.     Invest it all immediately
2.     Invest in regularly scheduled intervals
3.     Invest with an opportunistic approach based on market fluctuations

Each option carries certain risks and benefits, and no one approach is the “right” approach for everyone.

Over the long term, research indicates that on average investors benefit the most by investing it all immediately. Investors begin to earn income in the form of dividends and interest right away, which, when reinvested, begin compounding and increases the rate of return over time. This compounding makes a big difference in the long run as dividends buy more shares of stock and those shares earn increasing dividends over time. While this may be statistically the best approach on average over the long term, it may not be the best for every investor over the short or long term.

As with any average, there are data points above and below the average. This approach means that all capital goes into the market immediately. For someone who is unaccustomed to having significant liquidity, and with the daily gyrations of the equity markets, this can be very unsettling. The primary focus should always remain on the long term with the knowledge that investors will need to weather market corrections over full market cycles. This can be mentally challenging for many investors since people are hardwired to make decisions based on their emotions.

A systematic approach based on investing capital at regularly-scheduled intervals is often the ideal way to fully invest. For many investors, having a significant amount of cash provides stability and security as they experience the day-to-day value fluctuations of their portfolio. One of the primary reasons for poor investment performance is investors’ inability to withstand downturns in the market, leading them to “sell low and buy high.”

By taking the calculated time to invest, over a period of four quarters, for example, an investor can determine whether they are able to tolerate the volatility of their portfolio before they are fully invested, and have room to make changes so they have the ability to stay the course over the long term. The cost of a systematic approach to investing is the opportunity cost of not being fully invested in a rising market. As prices rise, investors potentially pay more for the shares they are buying. Likewise, there are times during the year when prices rise in the short term due to factors such as options expiration or index reconstitution, so choosing the best day to invest is also an important part of the plan.

An opportunistic approach has potentially the highest reward as well as the highest opportunity cost, and only makes sense for certain types of investors. Since 2010 there have been five corrections of 5 per cent or more in the stock market, with the last one occurring in 2012. Since January 2013 the S&P 500 is up over 40 per cent. If an investor has waited, keeping his or her capital in cash rather than investing, that opportunity cost can be significant. Another approach is to have some exposure to the stock or bond market while waiting for individual stocks or sectors to decline in order to seize an opportunity to invest.

Most opportunistic investors are comfortable with taking concentrated positions or piling on risk when prices have declined precipitously. Many people claim to do that, but it is rare indeed. To buy when the world is running for the exit is where an investor can find the most value, often generating exceptional returns. As compared to the previously-described methods of market timing, the opportunistic approach is for the rare, deep-value investor.

Often the best approach is a blend of two or all of these methods. In a situation where a market correction does not occur, clients can systematically invest some portion of their capital at pre-determined intervals in the future. Whichever method the investor chooses, finding one which aligns with that individual – his or her personality, investment perspective, liquidity needs and risk tolerance – allows him or her to stay committed. This requires that investors have a plan of action for making and monitoring their investments in the market place so that they know when and how to adjust the mix of their investments. Preparing for the “what ifs” before getting invested can reduce stress levels in the future.

The primary pitfall associated with all of these approaches can be the missed returns or negative returns if market timing is off. One of the most difficult adjustments for investors to make after owning, then selling their business is that the value of their assets now fluctuates on a daily basis. This is why putting a plan in place is so critical for long-term success – through bubbles, trends and market corrections.