Introduction
With the broader making new highs every other day, thoughts of selling out will surface and those who have not invested will want to stay away.
This is because whenever stocks hit an all time high, they climb a wall of worry. At every juncture there are concerns that a crash is waiting to happen. There will be discussions of inflationary woes, market is overheating, higher interest rate, a recession is round the corner et cetera.
We see articles by Charlie Munger where he warns of gambling mentality in the markets and the famous Michael Burry said “The market is dancing on a knife’s edge” because investors are taking on unsupported risk. Ray Dalio has called out a bubble territory.
While there are merits to their statements with an increase in leverage where investors are trading on margins and markets at high valuations all these are noises in the market. No one can predict anything in the short run.
Such noises in the market causes fear and people are afraid to invest as they do not want to see their investments tank. When markets are expensive, there are periods of underperformance.
This is why you do not invest all your money at once.
DOLLAR COST AVERAGE is proven to be the best strategy and in the long term, you will live through a crash. As Napoleon Hill once said, “Don't wait/ The time will never be just right.”
We are merely a market participant not any influential fund that can move markets.
By the way, even experienced investors took massive losses. For instance the AMC and Game-stop saga. Furthermore, we are not physic with the ability to predict the future and hence, you should not time the market.
Not convinced? I will provide 2 case studies to further solidify this point
You may not enter at today's prices. Ever.
First, you should never try to time the markets by selling out at highs and buying the bottom.
This is because you may never enter at today’s prices again. Say you accurately predicted the S&P500 to crash in 2019 (3,200 level). Your prediction came through when COVID struck in 2020 (2,3000 level) when the S&P500 took a dive.
However, therein lies the problem, what if you mistimed the buy in and expect the markets to continue dropping? You could be hoping for a better price and hence did not buy in.
What happened next? We saw a V shaped recovery and the S&P500 kept rallying to new all time highs at (4,200 level)
What did you realise? You got the timing right to sell and “benefitted”, but you failed to participate and the markets rallied. Now, you will never see the 3000 levels again.
Hence, your entry price will most likely start from 4000 onwards.
Drawdowns are usually shallow and fast
Drawdown happen every year,10-12% on average.
This means that drawdowns are pretty shallow and rebound quickly. Selling out and waiting for a big crash may not happen in many years. It only happens occasionally and we are more likely to see a correction instead.
A correction is usually around 20% and it rebounds fast.
This is why it is extremely tough to time the market. What happens if you ride out the pain?
A few months later you are back to square one. What is even better is to buy the dip if you have cash. This will effectively increase your rate of returns.
Closing thoughts
The question is then raised, how much cash should there be in my portfolio?
If you are on margin, that means you are heavily invested and you could be overly greedy. This is especially dangerous if you do not know what you are doing.
On the other hand, there are some who are holding 60-80% cash in their portfolio. They could be waiting for a crash before entering the market.
My suggestion is to have approximately 20-30% cash and not on the extreme ends. Not too much cash and being on margin as it puts you in an unfavourable position. Think of yourself as a soldier. You will not empty your rounds at the start in anticipation of more threat ahead.
Similar to life, your portfolio will go through the ups and the downs. It is inevitable, the soon you can come to terms with this fact the better of an investor you will be. It is paramount for you to learn from your mistakes and make more sound decisions as your portfolio grow.