3 Losers' Games That Investors Shouldn't Play

 | Jul 29, 2018 | 4:53 PM EDT
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Market timing is an alluring concept which generally ends up costing investors tons of money.

Being out of the market when it's going down, but fully invested when it's rising, is easier said than done. You can only know that stocks are in serious corrections after they've dropped significantly. It's impossible to be sure an upward move is significant until major averages have surged already.

Missing key turning points, which are only evident in retrospect, removes any advantage sought by trying to outsmart the indices.

Keep in mind that every stock market selloff in history has been temporary.

Ignore the present day situation, which remains to be played out. Each of the 5% to 10% corrections, and even 20%+ bear markets, has been nothing but a prelude to new all-time highs.

Fifteen out of fifteen of the greater than 5% declines in the S&P 500 since the March 9, 2009 bottom led to new records within months, not years. 2018's greater than 10% correction is virtually guaranteed to end that same way.

Market timing equals losers' game #1.

Ibbotson's classic data on Stocks, Bonds, T-Bills and Inflation (SBBI) illustrates the inherent upward bias in equities and the futility of trying to build long-term wealth using fixed income vehicles.

Recent Federal Reserve Bank policies, which artificially set interest rates to below-market levels, made those trends even more favorable towards stocks versus everything else. Note, too, that the chart below only ran through Dec. 31, 2016. Equities have had a superior run over the last 18 months, further skewing the disparity between total returns on stocks versus bonds and short-term paper.

Those same return profile relationships held over the most recent five-year period as well. In the half-decade ended April 30, 2018, fixed income failed to offset inflation and taxes. Owning those instruments, whether government bonds, bills or munis, meant suffering very real losses in true purchasing power.

Putting long-term investment capital into fixed income, rather than growth vehicles like stocks, real estate or private business ventures is losers' game #2.

Some investors who do hold heavy equities stakes insist on wasting money buying protective hedges like index put options. Once in a while, these hedges pay off. The problem is that most of the time they prove to be entirely unneccesary, and very expensive.

On May 30, 2018, with the broad market up big, a slightly out-of-the-money $270 strike price (SPY) put cost $10.85 per share with the S&P 500 ETF at $272.78. That equates to almost 4% of the current price for about 7.5 months worth of downside protection. The put's "insurance coverage," though, wouldn't kick in until the SPY had fallen by $2.78 from its trade inception quote.

The cost of the option combined with the dip to the strike price acts just like a 5% deductible on a real insurance contract.

The simple math says, then, that buying the protective put won't prevent the portfolio's holder from suffering the first 5% decline anyway. Worse, if the market goes sideways or higher during the period covered, that investor would be 5% worse off than someone who ignored hedging tactics.

Keeping put protection in place all the time could easily ding portfolio results by about 8% annualized. Spending 8% per year to ensure you won't lose big virtually guarantees you can't win much either.

Trying to hedge away risk, rather than simply creating and holding a solid portfolio, is losers' game #3.

Equities represent your best chance to build wealth over time. They are liquid, often produce dividend income and can shift income into favorable tax status (LT cap-gain rates) as well.

Keeps things simple, avoid losers' games and you'll be well on the path to financial security.

(This commentary originally appeared on Real Money Pro on July 16. Click here to learn about this dynamic market information service for active traders and to receive daily columns like this from Paul Price, Bret Jensen and others.)

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