What to learn: If overall stock market declines turn out to be temporary, not permanent – and this has been the case in most countries in recent decades – the "in-out" strategy is a tricky one: If you then fail to truly master "market timing" – if you sell too late (after the price high) and get back in too late (after the price low) – your investment returns suffer for two reasons: first, you miss out on returns, and second, your investment capital melts away.
The latter is explained as follows. Suppose you have 10.000 Euro and buy 100 shares for it at the price of 100 Euro. Then the price falls to, let’s say, 60 euros. Hold or sell? You lose your nerve and sell – and have only 6.000 euros. Then the price rises to, say, 80 euros, and you invest again. However, with your 6.000 euros, you can only afford 75 shares. So even if the share price subsequently rises to 200 euros, they still only come to a fortune of 15.000 euros – compared to 20.000 euros with the hold strategy ("buy-and-hold").
Better than the market in the long run?
The preceding example leads us to the central question that every investor should ask himself, and which he should also answer thoughtfully. It is: can I do better than the stock market, yes or no? If you think you can’t, then it is only logical to invest passively, i.e. buy a world stock market index or ETF.
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If you come to the well-founded conclusion that you cannot achieve a return with your investment decisions that is permanently higher than the return of the overall market, the logical consequence is to keep your hands off market timing and stock picking altogether. You should then not even think about in which regions (USA, euro area or China) to invest. A low cost world stock market index is the solution for you.
On the other hand, should you come to the conclusion: Yes, it is possible to permanently outperform the world stock market, you have to ask yourself in which way you want to and can actively invest. One way is to rely on market timing. But this is – as already mentioned – not a viable path for most investors. What remains is to try to achieve "outperformance" through stock selection: One invests very specifically in companies that generate consistently high returns on capital employed.
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However, this approach requires effort and time: You have to track down suitable companies and evaluate their business models with sufficient accuracy. One or the other investor probably has enough interest and expertise to master these tasks. However, if you don’t trust yourself to do that, you should work with suitable investors: investors who focus on single stock analysis and who don’t get bogged down in undesirable market timing capers.
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Whether you are a passive or an active investor, you need to have staying power and be able to cope with temporary setbacks. Market timing is great without question, when it succeeds. But it costs the investor dearly if it goes wrong. As far as I am concerned: Unfortunately, I do not know any investor who has become really successful in the long run with market timing. And unfortunately I don’t know anyone who knows anyone who would have come to the finish like this either.
Maybe this is a cynicism Oscar Wilde had in mind. Well, in any case, there is much to suggest that Wilde’s cynicism – seeing things as they are – will help the investor move forward.