For years, common wisdom has boiled down to a simple three-word strategy: Buy and hold.
It is almost universally agreed upon that holding onto high-quality investments for a long time is the best, if not the only, way to make big money long-term.
But the latest revision of a famous investment study highlights why so many people try to do something different: time the market and play the hot sector. It may also affect the way you look at your own investment strategy.
CDA Wiesenberger, the Rockville, Md.-based research firm, revised a study its company founder started in the 1940s comparing the results of investors who play market sectors, who time the market or who simply buy and hold for the long haul.
Here are the three scenarios:
“Susan Selector” can choose the market sector that is going to be the big hit for the next 12 months. At the start of each year, she puts her money into the best sector.
“Timothy Timer” is so smart he can pull his money out of the Standard & Poor’s 500 right before any month in which the index has a downturn and put it back in right before any month during which the market is about to turn around and go up again.
“Guy Buynhold” rides it all out in an S&P 500 index fund.
All three, in the latest version of the Wiesenberger study, started with $1,000 in 1983 and added nothing to it.
Fifteen years later, Buynhold has $11,817. That’s an annualized return of more than 16.5 percent, not too shabby.
But Timer has $73,000. Selector, up nearly 40 percent annually, has $115,000. If all three are neighbors, Selector is eating lobster while Buynhold chows down on Hamburger Helper.
The results are hardly surprising. Look at any performance list and the top funds almost always are sector funds focused on industries that are hot. But the bottom of those same charts is equally filled with funds in sectors that have gone cold.
Still, the earning potential shown by perfect selection and market timing gives supporters of those disciplines hope that they have the right answer to investing.
In fact, even investors who swear by the gospel of buy-and-hold move money around, hoping either to make a decent sector play or to have perfect timing and catch a rising star.
That’s fine in moderation, because the cost of making timing and selection mistakes can be devastating.
Consider what would have happened had Selector been a lousy investor, buying into the least successful sector for each coming year. Her $1,000 would have shrunk to $172 over 15 years.
And while Wiesenberger did not figure out the cost of “imperfect timing,” most timing practitioners acknowledge that they would be happy to be right on two out of every three tries.
“I don’t think the study is an endorsement of sector investing or market timing because no real person is going to come close to perfection, and your mistakes will be very costly,” says Stephanie M. Kendall, Wiesenberger’s senior fund analyst and author of the revised study.
Indeed, the study should make investors reconsider timing and sector selection, even if it does not change basic benefits to be gained from sticking with buy-and-hold.
“The idea behind market timing is to limit your losses and let your winners run, which develops a respectable low-risk return,” says Holly Hooper-Fournier, co-editor of the Mutual Fund Strategist, a timing newsletter based in Burlington, Vt.
Playing sectors, meanwhile, goes the other way, reducing diversification and adding some volatility to a portfolio.
“It doesn’t have to be all-or-nothing; the portion of your money that you consider `aggressive growth’ can be allocated to sector funds,” says Sam Stovall, sector analyst for Standard & Poor’s Corp. “If you do some research and find sectors you expect to do well, you can buy into those sectors for a while. Yes, it adds a market timing element to your portfolio, but that’s not always bad.”
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Charles A. Jaffe is mutual funds columnist at The Boston Globe. He can be reached at The Boston Globe, Box 2378, Boston, Mass. 02107-2378 or by e-mail at jaffe@globe.com.
