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Friday, 20 February 2009

When Buy-And-Hold Beats Bad Timing

Paul Katzeff

Are you still trying to figure out if you should have gone to cash six months ago? Nine months ago? Twelve months ago?

Well, stop beating yourself up. Your gut instinct to stay invested may have been the right move all along.

At least that's the verdict of a recent Fidelity Investments study.

The study from Fidelity's Market Analysis, Research & Education unit shows that buy-and-hold investors who stuck to a strategy of dollar cost averaging in the S&P 500 during the 1990-91 and 2000-02 bear markets outperformed three market-timing strategies that are all too often followed.

Using dollar cost averaging, the stay-the-course investor would have 5.6% more money in his portfolio than one who used the least successful of the three timing tactics.

And after 30 years, the stay-the-course investor would have a balance of $617,331. That would be $34,752 more than the least productive of the three timing strategies.

The study was intended to reassure today's investors that bailing out of the market is the wrong move.

The 2000-02 bear market is especially relevant. Like the current downturn, it was an extended bear market that got a lot worse after hitting the 20% threshold that defines a bear market.

"Dollar cost averaging is a way to realize the market's returns over long periods," said Chris Sharpe, co-manager of $70 billion in 28 Fidelity Freedom Funds and an in-house expert on dollar cost averaging. "And it avoids perils of market timing."

The study tracked four hypothetical investors. Each started with $10,000 invested in the S&P 500. Each invested another $500 monthly. "The idea is the same whether you invest in an index fund or individual securities," Sharpe said.

A stay-the-course investor kept investing through each downturn. He invested the same amount each month. As the market fell, each dollar bought more shares.

Failed Strategies

Fidelity nicknamed one of the market timers the "bear-market dodger." After the start of the downturn in March 2000, for instance, he shifted new contributions to cash, beginning in April 2000.

A second market timer, the "bear-market refugee," shifted new contributions once the bear market was official -- hit the 20% down threshold -- to cash starting in March 2001.

The third timer was dubbed the "doomsday capitulator." He shifted new money to cash at the market's low point 14 October 2002.

In the real world, the key danger in market timing -- especially with funds -- is the difficulty in knowing in advance the best time to get out of the market and the best time to get back in.

A late return to the market usually means that an investor misses out on the typically explosive start to a new bull run.

The three timers resumed investing in stocks as of January 2004. In the real market, that was when investors' cash weightings fell back to their long-term averages as investors returned to stocks, Fidelity says. Going forward, each portfolio got the bogey's 10.2% average yearly gains from 1927 to August 2008.

January 2004 was also the point 14 time when Fidelity measured how each strategy had fared.

After plowing in $34,000, the stay-the-course investor's account balance was $33,502. That was bigger than the other three investors' by 0.4%, 5.1% and 5.6%, respectively.

Still, Fidelity says if the account exists for another 30 years, stay-the-course investor's $617,331 balance is $2,671 more than dodger's, $31,380 more than refugee's, and $34,752 more than capitulator's.

In reality, the stay-the-course investor is likely to outperform by even more, Fidelity says. That's because past market timers are likely to do it again in future downturns. Each time, the stay-the-course investor would outperform. His winning margins would compound.

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