Dear reader, don't play George Soros
What's wrong with holding cash, waiting to buy stocks at more attractive levels? Plenty.
NEW YORK (Money) -- READER QUESTION: In the past, you've said that investors shouldn't try to time their investing so they get in just before the market soars. While most of my investments are in stock funds, I have some cash parked in a money-market fund waiting for lower stock prices. I almost moved some of this cash recently when the Standard & Poor's 500 declined to around 1220, but I really want to invest at an S&P of 1200. Meanwhile, the cash is earning 5 percent. What's wrong with this approach? - Alan S., Silver Spring, Maryland
If you're talking about a relatively small sum of "mad money" that you can afford to play around with, then there may be little or no harm in trying your hand at a bit of market timing.
In fact, as long as you restrict yourself to sums of money that won't jeopardize your financial security, I suppose this go-with-your-gut approach could even be helpful in a roundabout way. Maybe by tracking your results - which I fully expect will be underwhelming over any lengthy period - you'll see why jumping in and out of the market is largely an exercise in futility.
Or maybe exercising the risk-seeking side of your nature while keeping it on a short leash will satisfy your need for titillation and prevent you from doing something stupid with your real money.
But if you're talking about money that can make a real difference in your life -and, for most of us, I think virtually all of our savings falls into this category - then I think it's foolish and possibly downright dangerous to base your investing strategy on some quixotic view that you can judge the best times to enter and leave the market.
You say you want to buy into the stock market when the S&P 500 hits 1200, which is 7 percent or so below its recent level. Well, that's nice.
What if you never hit your buy-point? But your wish has nothing to do with whether the S&P 500 will actually get to 1200. Maybe it will, or maybe it won't. If it doesn't, does that mean your money just stays in the money-market account indefinitely? Or do set another level that you hope the S&P will fall to before you invest? And if so, do you use the same method for setting that level as you did in coming up with 1200 as the trigger point?
What if you don't have the nerve to follow through? Besides, I'm not sure you'd actually pull the trigger at 1200. Investors who swear they'll buy when a stock dips to a certain price often don't follow through. If the market is crashing when the stock or index hit the "buy-point", investors sometimes get cold feet because they worry things will only get worse.
That's the problem when you get into this market timing business. There are so many possibilities and once you start trying to figure out (read: guess) what might happen next, your mind can get twisted around like a Philly soft pretzel.
A better approach
That's why I think you're much better off building a well-rounded portfolio that contains a mix of different types of stocks and bonds that's based on what sorts of short-term swings in your portfolio's value you can stomach and your investing time horizon.
The more yo-yoing around you can stand the longer you'll have your money invested, the more you can afford to put in stocks. The more that dips in your portfolio's value frighten you and the sooner you'll need your money, the more you ought to put into bonds. For guidelines on how to create such a mix based on your own preferences and needs, check out our Asset Allocation tool.
By taking this approach - and sticking to your plan by bringing your portfolio back to its proper proportions (or thereabouts) every year or so - you take the guesswork out of investing and you instill some discipline.
What you'll also find is that by rebalancing your portfolio's mix of stocks and bonds every year, you'll tend to sell some assets that are riding high on the performance charts (and thus may be becoming more vulnerable to a setback) and investing in assets that aren't as popular (and thus may be getting ready for a nice run). There are no guarantees that this approach will lead to the best returns. But it will prevent you from getting slammed by putting all or most of your money in an investment at a particularly bad time.
I suggest you read the MONEY 101 lesson on asset allocation, which explains in greater detail the theory behind the virtues of spreading your money around to achieve a nice balance of risk vs. reward.
I also recommend that you take a look at my column in the September issue of Money Magazine that explains why a straightforward approach like building a balanced portfolio is likely a better strategy than many of the supposedly "sophisticated" strategies that are being pitched to investors these days.
If after checking out this information, you still want to invest more than a token amount of money using market timing or similar strategies that are the investing equivalent of playing with fire, well, I wish you good luck. But don't say you weren't warned if you get burned.