As we established in our recent posts “Assessing the Probability of a Stock Market Correction” and “Are There Strategies to Handle Stock Market Corrections?,” market pullbacks are fairly normal occurrences within bull markets. We also pointed out some features that identify stock market corrections - they’re relatively short in duration, vary in size, and perhaps most importantly, they’re unpredictable when it comes to identifying when they’ll start and end.
It’s the last point that makes short-term market timing strategies not only difficult to execute, but also potentially harmful to investors.
With stock market corrections, there are no clear warning signs for when investors should sell out of equities or when it’s time to reinvest. That creates two clear risks to short-term market timing strategies:
An investor sells out of equities in an attempt to time the market correction correctly, but the stock market continues to rise.
An investor might get it right and sell out of equities before a stock market correction, but then it becomes a question of when to reinvest. There is the risk that he or she misses out on the upside of the recovery.
In certain instances, investors have to pay transaction costs to buy or sell holdings in their portfolios, usually in the form of trading commissions. If making trades is a monetary cost to the portfolio, it could also have a negative effect on total return.
Taxes may also become a factor, if some of the trades made in the market timing effort result in capital gains. If those gains aren’t offset by losses by the end of that year, that could result in an unwanted tax burden.
Taken together, if an investor were to get their short-term market timing strategy wrong while also paying transaction costs and realizing gains, it only worsens the financial impact of their decision.
For people with long time horizons (10+ years or more), the length of a correction (a few weeks or months) is a small period of time relative to the length of time they need their assets to grow. The impact of a correction may only be temporary for those who remain invested, although it can be difficult to endure while it is occurring.
The benefit of potentially earning a few more percent by using short-term market timing strategies to time stock market corrections perhaps doesn’t outweigh the potential costs of getting the timing wrong. However, as we mentioned in our piece “Are There Strategies to Handle Stock Market Corrections?,” there are strategies available whose objective is to try and help limit losses in portfolios during prolonged downturns in the market
If you want to learn more about these strategies while also further discussing how to potentially handle corrections and bear markets, and strategies whose objective is to try and help limit losses in portfolios from prolonged downturns in the market, please call one of our Wealth Managers today at 1-800-541-7774. Alternatively, you can download our report “Looking for Downside Protection?” here.
Additional Disclosures:
WrapManager, Inc. is not a tax advisory firm. We recommend you contact your tax attorney or CPA prior to utilizing any of the tax-related strategies mentioned or discussed.