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An Investing Strategy That Even the Pros Can’t Get Right

Asset allocation would likely be a familiar term for most. At its most basic, it’s an investment strategy whereby each individual divides his or her capital into a static mix of different asset classes (like bonds, stocks, cash, properties etc.) depending on their individual circumstance.

Tactical asset allocation on the other hand, might be a slightly more alien concept. At its core, it’s about asset managers who are able to nimbly switch from one broad asset class to another in their search for higher returns with lesser volatility.

Different managers might use different techniques (such as valuation methodologies or technical indicators), but the end goal is the same – they want to be in an asset class when it’s on the way up, and get out right before things turn sour.

To financial advisor and behavioural investing expert Carl Richards, tactical asset allocation sounds a lot like trying to time the market and it is. In shares, timing the market is the act of trying to buy into a share right at its bottom, and selling it right at its peak. It’s something that tactical asset allocators are trying to accomplish with broad asset classes instead of with individual shares.

But as attractive as the idea sounds, the fact is, getting a higher return with lower volatility stemming from tactical asset allocation is just an elusive dream.

The American investment advisory outfit Morningstar published a study back in Feb 2012 titled In Practice: Tactical Funds Miss Their Chance that compared the performance of the Vanguard Balanced Index with a total of 210 funds that employed tactical asset allocation strategies. According to Morningstar, the Vanguard Balanced Index “passively invests its assets in a 60%/40% stock/bond mix.”

The study covered a 17 month period from 31 July 2010 to 31 Dec 2011 and found that the tactical funds simply couldn’t outperform the Vanguard Balanced Index with any conviction.

The study period was short, but particularly instructive. The period of Aug 2010 to April 2011 was a strong bull market in the USA that saw the S&P 500 Index (an American stock market benchmark) gain 21%; the US stock markets then entered a sharp correction phase from May 2011 to Aug 2011 where the S&P 500 fell 17.5%; and finally, from late Aug 2011 to the end of the study period, the index rebounded 11.9%.

So, there were large swings in American stocks which should have benefitted the tactical allocators (i.e. market timers) well if they were able to sell before the drop and pick up the scraps at the bottom. But as it turns out, they weren’t able to do so.

The point of all these, is to really highlight the futility of trying to time the market. Sure, there will be some who can excel at it and there’s nothing wrong with that at all. But, when you have the majority of funds – with their army of analysts and powerful computers – being unable to achieve their aims of timing the market with any conviction or precision, the odds of mom and pop investors being able to do so successfully become dramatically lower.

As such, sticking to a proper investing game plan without trying to jump in and out of the markets would likely give an investor better odds of success.

One such ‘game plan’ would be having the tenacity and patience to invest methodically for long stretches of time that are measured in years and decades. A nice example would be how a monthly investment of S$500 at the start of every month in the year 2003 in the SPDR Straits Times Index ETF (SGX: ES3) would have grown to S$12,636 by mid Dec 2013.

That’s more than a double (as a total of S$6,000 would have been invested in 2003) in 10 years and also a testament to how our local stock market in Singapore has grown as the ETF basically tracks the movement of the Straits Times Index (SGX: ^STI), which is the most widely-followed barometer for Singaporean shares in general.

Another statistic that I find to be quite remarkable is how the odds of losing money in the Straits Times Index becomes dramatically lower the longer an investor chooses to remain invested in it.

Trying to time the market is a flimsy investing strategy at best as even the professionals – armed with their army of smart analysts – couldn’t do it, as shown in the Morningstar study. Instead, having the patience to invest for the long haul and making time your greatest ally in investing matters helps build a much stronger foundation for success.

The last word here goes to investor Nick Murray, who once said, “Timing the market’s a fool’s game, whereas time in market is your greatest natural advantage.”

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing doesn’t own shares in any companies mentioned.