Q4 2016 CIO Insights: Asset Allocation
This election-themed CIO Insights gives us the chance to weave together some key topics and ideas we’ve been writing about lately. First, making investment decisions based on the outcomes of votes or legislative processes is essentially a market-timing strategy. These strategies are incredibly hard to get right. Second, the basic building block of financial success is developing and sticking to a robust plan to meet your financial goals—making bets on the party of the next president never enters into the equation.
Market Timing Is Tough
Moving in and out of sectors or asset classes based on who wins or loses an election is a market-timing strategy. We routinely quote research from fund industry analysts DALBAR and Morningstar showing that individual investors hurt their performance by making poorly timed buy and sell decisions. Not only do retail investors fail to add value through market timing, but there is plenty of research to show that even the most sophisticated institutional investors also subtract value through their trades. From novice to expert, it turns out that it is extremely hard to profit from timing market movements.
“Better that you should stick to the plan you’ve developed, than let your financial decisions blow with the political wind.”
To see why this might be so, let’s look at the recent vote by the United Kingdom to leave the European Union, referred to as Brexit. Stocks around the globe sold off sharply in the wake of the June vote. But within days, markets had begun to rally back. As of late August, both the U.S. and U.K. equity markets are higher than they were before the vote; stocks in other developed markets have essentially recovered all their losses. To outperform a buy-and-hold strategy, you would have had to foresee the sell-off and get out of your stock position prior to the vote, and then correctly call the bottom to get back into the market just days later. That’s two very difficult timing decisions, not one.
Data show that investors often sell after market declines, rather than before, and then buy back in after the recovery. As a result, investors pursuing timing strategies typically capture a disproportionate amount of the market downside and miss out on a portion of the upside. To see what that might mean in practice, we looked at U.S. stock market data going back to the Great Depression. We find that the market produced 10% average annual returns in that time, and that missing out on just the 10 best months lowered that number to 7.6%. It was a similar story looking at even daily returns.
The Plan’s the Thing
Simply developing a financial plan is one of the most powerful steps you can take on the road to financial success. However, defining objectives and specific methods you will take to reach your goals over time is useful only to the extent you adhere to the plan—abandoning your strategy at arbitrary points along your financial timeline is definitively not one of the steps any financial planner we know would encourage!
Financial planning is important precisely because we live in an uncertain world where outcomes can’t be known in advance. In electoral terms, even after the votes are tallied, the legislative process and economic outcomes can remain messy and uncertain for a prolonged period. This is more or less how investing is all the time, not just in election years. We believe it’s best to recognize that external factors are beyond your control, and have little to do with whether or not you reach your financial goals over time—that’s largely down to your own saving and investing decisions. Better that you should stick to the plan you’ve developed, than let your financial decisions blow with the political wind.
The opinions expressed are those of Scott Wittman, CFA, CAIA, and are no guarantee of the future performance of any American Century Investments portfolio.
International investing involves special risks, such as political instability and currency fluctuations.
For educational use only. This information is not intended to serve as investment advice. Past performance is no guarantee of future results.