Market timing for dummies: Tips and techniques

Here’s a hot investment tip: Don’t try to time the markets, because it doesn’t work.

No one knows when a market has hit bottom or when it has topped out. Anyone who promises to show you on a consistent basis how to buy low and sell high is peddling snake oil.

In fact most people behave in just the opposite manner: They buy high and sell low, because they make their investment choices based on their emotions, the two most dangerous being greed and fear.

When markets boom, people get greedy and do very foolish things. (We wish we had a dollar for everyone who asked during the late ’90s if we could get them in on some hot Internet IPOs.) When markets slump and gloom spreads across the land (as in the early part of this decade), people become fearful and sell. They don’t want anything to do with “risky” investments  although when markets were rising (and risks were even higher), these investments were fine as far as they were concerned.

There are some strategies to filter out the noise that goes on every day in the investment markets. We’ll show you two, both designed to take emotion out of investing and do a little market timing without having to think about it. The strategies can work in any market environment, although we can’t guarantee their future success. But we know that in the past they have produced superior returns while minimizing risk.

The first strategy is asset allocation. This simply means deciding based on your risk tolerance and time constraints the types of investment assets to hold – broadly stocks, bonds or cash – then shifting among the types every year or so to bring the portfolio back into balance as market conditions change.

For example, say you are comfortable with an asset mix of 80% stocks, 20% bonds. Fourteen months later, due to market fluctuations, your stocks shrunk to 75% and your bonds had grown to 25%. You would reduce your bond allocation and buy stocks to restore your original balance.

You would continue to do this regardless of market conditions or what the prognosticators say. Unless your goals or the timing of those goals change, you stand by your allocations.

The second method of market timing for dummies is dollar-cost averaging. This is adding a fixed amount on a regular basis to an investment that fluctuates in value. The result is that you buy more when the price is low, less when it’s high, and your average cost per share is actually less than its average price.