Money Magazine
Money Magazine's undercover financial planner

The myth of the market crystal ball

Trying to predict market swings usually results in buying and selling at all the wrong times.

Subscribe to Personal Finance
google my aol my msn my yahoo! netvibes
Paste this link into your favorite RSS desktop reader
See all CNNMoney.com RSS FEEDS (close)
By The Mole, Money Magazine's undercover financial planner

Lies planners tell: A pro knows
An undercover financial planner exposes industry intimidation tactics and tells why keeping a portfolio simple may be the best bet.
mole_new.03.jpg
Ask Money Magazine's undercover financial planner a question. Send e-mails to: themole@moneymail.com.
SUBMIT

NEW YORK (Money) -- Question: I'm in an 85% stock mix and thinking about moving my 401(k) dollars to a preservation type of fund. I predict a continuation of the downward trend in stocks over the next year. Should I get more conservative?

The Mole's Answer: It's hard to recommend an asset allocation for you without knowing anything about you, but from your question alone it appears that you are too heavily invested in stocks for your psychological comfort level. I can definitely tell you that you are considering a change for the wrong reason.

You said you predict a "downward trend in stocks next year." Let's explore this a bit.

I give investing presentations to groups and always ask the group a few questions. One of these questions is what return they expect from the stock market. For the last couple of years, I consistently got responses of 15% to 20%, and even the most pessimistic responses were still a positive return.

Today, I'm more often than not getting responses with negative returns with even some of the optimistic predictions at a loss. So what gives?

Well, we can chalk this pessimism up to a phenomenon known as recency bias. This is a human behavior that leads us to place far more weight on what has happened recently than what happened years earlier.

For instance, a year ago we were solidly in the five-year bull market and feeling pretty good about things. The pain of the 2000-2002 bear market was a distant memory. A recent Money column asked Are you really such a daredevil? This column posed that question at the right time, when the market was hitting new highs.

Now that the stock market is down, daredevils are pretty hard to find. Fear and pessimism have taken over, even though we logically know the market is a better buy today than it was last October.

Our impulse to dial it back and get more defensive in a bear market can be traced back to those pesky emotions that insist on working against us. They make us masters of predicting the past and keep us systematically buying high and selling low.

Predicting the future

I can't tell you for certain that your prediction for the coming year is wrong. But I can tell you that there are two types of people when it comes to forecasting short-term market performance:

• Those who don't know how the market will perform next year.

• Those who don't know they don't know how it will perform.

I suspect you have been listening to the gurus in the second camp. They also do a great job of predicting the past and seem optimistic after an up market and pessimistic during a down one.

I suggest you do two things:

1. Pick an asset allocation and stick to it for the long-run. If you don't need the money for 10 years or more, then you can probably have a high allocation to stocks, if you can stand the pain of a down market without panicking and selling. But if you're going to move in and out of the market, then you may actually be better off in money market funds. That's because your penalties for trying to time the market are likely to take from your return and yield less than an FDIC insured money market. One of my favorite sayings is "if you can't be right, at least be consistent." Sticking to your asset allocation may be more important than picking it in the first place.

2. Rebalance periodically. Market swings can throw off your allocation. So to stick to your selected mix, you might need to do some portfolio housecleaning. There is a systematic way to boost your return by buying low and selling high. Whatever allocation you pick, periodic rebalancing will ensure you sell some of your stock funds in an up market, and buy more in a down one. This is a far better way to invest, though not an easy one. It takes nerves of steel to overcome our instincts and to buy something disappointing, and sell something that has brought us pride and pleasure.

Studies show that, in addition to adding unnecessary costs, we also tend to underperform the market because of performance chasing, often with the encouragement of our financial advisers because what goes up is easier to sell. Learn more about how you may be making emotional mistakes from Jason Zweig's, Your money and your brain.

My advice: Give up on the illusion that you or anyone else knows what the market will do next year.

I think you'd be far better off in a 50% stock portfolio, and staying there, rather than being 85% in the market one year and completely selling out of it the next. The more you try to outsmart the market, the more it outsmarts you, and the lower your returns are likely to be.


Worried about your investments? Get a makeover from Money Magazine. E-mail us at makeover@moneymail.com.  To top of page

The right time for a conservative portfolio

When it's time to dump your broker

Where to invest for the short term


More from the Mole in Money Magazine:

Truth or dare for your financial adviser: Put your prospective planner's frankness to the test with these four tough questions.

When to tell your planner you'll sleep on it: Why you shouldn't rush to act on advice, no matter how good it sounds.

Retirement: How much you'll really need: Sure you could live more cheaply in retirement. But some costs will go way up.
Photo Galleries
8 CEOs who took a pay cut in 2013 Median CEO pay inched up 9% in 2013 to $13.9 million. But not everyone got a bump last year. Here are eight CEOs who missed out. More
7 businesses Amazon wants to shake up From industrial supplies to educational software, Amazon is about more than just retail and books. More
Don't miss these Tax Day deals From massages and paper shredding to cookies and queso, celebrate the end of tax season with these Tax Day freebies and discounts. More
Market indexes are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer LIBOR Warning: Neither BBA Enterprises Limited, nor the BBA LIBOR Contributor Banks, nor Reuters, can be held liable for any irregularity or inaccuracy of BBA LIBOR. Disclaimer. Morningstar: © 2014 Morningstar, Inc. All Rights Reserved. Disclaimer The Dow Jones IndexesSM are proprietary to and distributed by Dow Jones & Company, Inc. and have been licensed for use. All content of the Dow Jones IndexesSM © 2014 is proprietary to Dow Jones & Company, Inc. Chicago Mercantile Association. The market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. FactSet Research Systems Inc. 2014. All rights reserved. Most stock quote data provided by BATS.
Market indexes are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer LIBOR Warning: Neither BBA Enterprises Limited, nor the BBA LIBOR Contributor Banks, nor Reuters, can be held liable for any irregularity or inaccuracy of BBA LIBOR. Disclaimer. Morningstar: © 2014 Morningstar, Inc. All Rights Reserved. Disclaimer The Dow Jones IndexesSM are proprietary to and distributed by Dow Jones & Company, Inc. and have been licensed for use. All content of the Dow Jones IndexesSM © 2014 is proprietary to Dow Jones & Company, Inc. Chicago Mercantile Association. The market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. FactSet Research Systems Inc. 2014. All rights reserved. Most stock quote data provided by BATS.