Some say market timing is an investing sin. If it is, some ways of sinning are better than others. We have discussed why the global market portfolio is a good starting point for building a well-diversified portfolio. Strictly speaking, an investor with any portfolio other than the global market portfolio has engaged in the shunned act of market timing.
The reality is we are all market timers. We’ve often said, and still believe, that trying to get in and out of the market to avoid losses is difficult. This type of market timing is typically counterproductive, but there are some fundamental strategies that can help improve your investing discipline.
Settle on an asset allocation. The percentage of stocks, bonds, and other assets you own matters more than which individual stocks you own. The global market portfolio is divided roughly into 50% stocks and 50% bonds. However, your situation may warrant a different mix depending on your desire for more growth or less risk.
Regularly rebalance. Over time, the mix of what you own will change. In any diversified portfolio, some assets do well when others do not, creating opportunities to sell recent outperformers and buy recent laggards. This imposes discipline to buy low and sell high with part of your portfolio. Over time, it can improve performance and smooth the ups and downs. Some investors rebalance on a preset day of the year. We think it’s better to set bands around your target portfolio and rebalance once your portfolio breaks these bands.
Control the international. The global market portfolio is split roughly equally between assets that are denominated in US dollars and other foreign currencies. While diversifying across currencies and non-domestic companies can help round out your portfolio, fifty-fifty isn’t for everyone. Most domestic investors eat, sleep, and play in their home currency, so owning a lot of foreign assets may not be appropriate. A moderate amount of currency exposure can improve diversification and could improve performance. Historically, having about a quarter of a diversified stock portfolio invested in international companies has worked well.
Manage the tax man. Individual tax situations are almost always unique. While taxes should not solely drive investment decisions, they should be considered when managing your portfolio. Often, this influences the composition of your portfolio. This could mean owning more municipal bonds for investors in high tax brackets. It could also mean opportunistically harvesting tax losses.
Tactically tilt the portfolio. It’s very hard to beat the markets, but when prices are historically low, future returns are likely to be better. Often these opportunities are between similar assets. For example, when shares of smaller companies lag shares of larger companies, it may be time to lean towards the smaller ones. This is no investing secret or silver bullet, but as the market’s appetite for certain types of risks ebbs and flows, leaning against the crowd may be advantageous for the patient investor. Tilting away from some parts of your portfolio while leaning toward others can be appropriate in the long run if this is done carefully and with a heavy dose of humility.
Technically, these are all activities in timing the market. But all this imposes discipline on managing your money. Often these decisions to get in and out of the market are emotionally driven. The urge to “take profits” after a good run or the fear of missing out are strong forces to counter.
The global market portfolio is a “set it and forget it” portfolio. We think it’s the starting point for constructing a well-diversified portfolio, but it’s not right for everyone. The key is coming up with a strategy you can live with and stay invested.