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Does This Count as Market Timing?

A reader writes in, asking:

“I am new to really paying attention to investing. Most sources seem to agree that market timing is a bad idea. But then I also have read a lot about buying I Bonds or TIPS because they have high interest rates right now. Why isn’t that market timing? Does market timing only involve stocks?”

“Does _____ count as market timing?” is one of the most common types of investing questions I’ve received over the years writing this blog. The answer, in my opinion, is that it doesn’t matter whether or not an investment strategy “counts as market timing.” All that matters is whether or not it’s a good idea.

Some people will apply the market timing label to any strategy that has anything to do with interest rates or market valuations, thereby declaring all such strategies taboo, despite the fact that there’s a huge variation as to:

  1. The level of risk involved and
  2. The probability of success.

To illustrate what I mean, let’s take a look at a few example strategies, any of which could be described as market timing, depending on who you ask.

Strategy 1: Moving Between Cash and Stocks Everyday

Bob has determined that he cannot afford very much risk, but he still needs high returns to meet his goals. So he decides to move his entire portfolio between 100% cash and 100% stocks from day to day in an attempt to catch the best days in the market and miss the worst ones.

Bob’s strategy relies entirely on predicting what the stock market will do over very short periods, which is pretty much impossible. And if Bob fails, he could experience losses that he cannot afford. This type of market timing is clearly not a good idea.

Strategy 2: Shifting Your Bond Maturities

At a time when interest rates are far below their historical averages, Steve shifts his bond allocation from intermediate-term bonds to short-term bonds. Steve’s thought process is that interest rates are likely to come back up in the near future, and he doesn’t want to experience the larger loss in value that would occur with bonds with longer duration. He plans to wait for rates to come back up, then switch back to intermediate-term bonds.

Steve’s strategy is essentially a guess that interest rates will soon go up. Predicting where interest rates will go in the near future is about as hard as predicting where the stock market will go in the near future. (So this is not, for example, a strategy that I would be interested in using myself.) But a key difference between this strategy and Bob’s strategy above is that if Steve is wrong (and interest rates do not rise any time soon), it’s probably not a disaster for Steve. He just misses out on the slightly-higher returns that he could have gotten by holding longer-term bonds.

Strategy 3: Moving from Stocks to Bonds (Permanently)

Laura is planning to retire in the near future. At the time Laura is making the decision, the last couple of years in the stock market have been good and TIPS yields are high. Laura decides to shift a significant portion of her portfolio out of stocks and into a TIPS ladder.

Laura’s strategy is based on recent market performance and current interest rates, but it doesn’t rely on any prediction at all. It’s simply a decision that current rates are good enough to carry her through retirement with very little risk.

The Point of “Don’t Try to Time the Market”

Because of the taboo we’ve placed on anything that could be described as market timing, investors are sometimes afraid to use all the available information when making their decisions. I do not think this is a good thing.

The point of the “don’t try to time the market” message is simply that new investors need to learn that it’s impossible to predict a) where the stock market is going next or b) where interest rates (and therefore bond prices) are going next.

But it can be OK to make financial decisions based on current interest rates or market values, as long as you don’t have to successfully predict where the stock market or interest rates are going next in order for the decision to make sense.

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