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Market Perspective
Resisting Temptation, Part 2
 by Ernie Ankrim, Ph.D.
Chief Investment Strategist
Frank Russell Company
November 7, 2002
This article has been provided by our parent company, and deals primarily with the US market.
In Part I, we discussed chasing past performance instead of taking a balanced approach. If that mistake is essentially about living in the past, trying to time the market is about living in the future. But there are ways to resist the temptation and stay focused on what's really important.
MISTAKE #2: Sitting on the Sidelines Until the Market Looks Less Grizzly
Investors who cashed out of the stock market are now waiting for the "right time" to get back into equities. That may sound like a sensible approach, but it's market timing, pure and simple.
Why it Happens
Although the futility of market timing has been documented again and again, many investors are still convinced that they will know just the right time to "get back in." In fact, many investors (especially individuals) actually enter the market at exactly the wrong time, buying at the top and selling at the bottom.
To a large extent, this mistake arises out of a misperception about risk. When an asset class is near its top and has been providing positive returns for a while, realized risk is, for the most part, minimal and investors flock to the market — even though latent risk actually may have increased. Conversely, when a market is at or near a bottom and investors have been losing money, realized risk is exceptionally high, so investors rush for the exits.
Why it's a Mistake
Anyone who watched Game 6 of this year's World Series knows a thing or two about stunning reversals. In the final three innings of the game, the San Francisco Giants saw their 5-0 lead over the Anaheim Angels turn into a 6-5 loss.
The stock market is not all that different. No one can predict when the tide will turn, though many people are still convinced that they can do just that. Back in 1973-74, for example, the US stock market was gripped by a bear comparable to what we've experienced since March 2000. As in the current environment, the temptation to retreat from the stock market altogether was great for many investors. Yet those who resisted that lure were well rewarded when the stock market quickly rebounded in the fall of 1974 and the first quarter of 1975.
If the equity market stages a similar recovery, investors who have given up on equities risk missing out on strong early-stage returns that could help them recoup some of their bear-market losses. If you were on the sidelines this last month, you missed one of the best Octobers in history. It's unclear whether or not the market's recent strength marks the beginning of a sustained recovery. But one thing is clear: Investors who haven't participated in the market's strength to start the fourth quarter have already missed out on a sizeable share of positive movement.
Strategies for Resisting Temptation
The temptation to live in the past by chasing performance or to live in the future by trying to time the market will always be present. That's why it's important to commit to a few sane, simple strategies that can protect us from the urge to do exactly the wrong thing at the wrong time.
Seek Balance
At Russell, we believe that the risk/return level of an individual's portfolio should be independent of what's happening in the market at any one particular time. A well-thought-out asset allocation plan can provide the framework to maintain that consistent risk/return level through the market's ups and downs.
To stay on track, though, any asset allocation plan needs rebalancing, and that can require something of a leap of faith. It calls for investing in what has been doing poorly while paring back on what has been doing well. More aptly, it's selling high and buying low. Right now, rebalancing may seem like an aggressive policy. In 1999, when large-cap growth and technology stocks seemed like they would continue going up and up and up, rebalancing appeared overly conservative. Investors who took that leap of faith anyway are likely to be in much better shape now than those who didn't. We may end up saying the same thing three years down the road about investors who decided to rebalance today.
Seek Guidance
When you're trying to resist temptation, guidance from an objective financial advisor can give you the willpower you need. Just don't be disappointed if he or she doesn't tell you everything you want to hear. Many people merely want to have their beliefs validated, even if they're flawed. Yet challenging yourself and your convictions can be far more rewarding. That's why I believe financial advisors are doing their clients a disservice if they merely confirm everything their clients already think. A more responsible approach is for a financial advisor to help a client explore his or her suppositions and plans to make sure they're consistent with the client's best interests over the long term.
Beyond serving as a sounding board, a trusted financial advisor can help you stay on course to your long-term goals and find more time to enjoy what's really important in the here and now — like family, friends and life beyond the daily market pulse.
Date of first use: November 13, 2002
The information, including any opinion, is based on various sources we believe reliable, but its accuracy cannot be guaranteed.
This is a publication of Russell Investments Canada Limited. It should not be construed as investment, legal, or tax advice. The contents are intended for general information purposes only, and you are urged to consult your own investment, legal, or tax advisor concerning your own situation and any specific investment questions you may have.
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