Many investors try to “time” the market by “buying low and selling high.” In theory, that’s a great idea – but it’s almost impossible to put into practice.
If you try to outguess the market, you run the substantial risk of guessing wrong – of buying stocks too soon, before they get even cheaper, or of selling stocks too late, after they’ve fallen from their highs. But these are only the most obvious of the problems that can result from market timing. Here are some others to consider:
•You could lose your investment discipline. The best investors are the disciplined investors. They choose quality stocks and hold them for the long term, through good and bad markets. In fact, they have conditioned themselves to ignore short-term price swings in either direction, based on their belief that their patience eventually will be rewarded.
•You could hurt your diversification. To succeed as an investor, you need to build a diversified portfolio. Your exact mix of investments will depend on your individual goals, risk tolerance and time horizon. Over time, as your situation changes – for example, when you move from the working world to retirement – you will need to adjust your portfolio. But if you’re constantly buying and selling in a vain attempt to time the market, you may well end up with a perennially “unbalanced” portfolio. Keep in mind, though, that even a diversified portfolio won’t guarantee a profit, nor will it protect against a loss in a declining market.
•You could run up transaction costs. Stock transactions can be expensive, as you rack up commissions and other fees. Over time, these costs can significantly erode your investment returns. If you are always trying to “buy low” and “sell high” you’ll be doing an awful lot of buying and selling.
•You could run up your tax bill. When you sell a stock for a profit, you must pay capital gains taxes. However, if you hold a stock for at least one year before selling, you will be assessed the most favorable capital gains rate, which is 15 percent for most investors. But if you were to pursue a buy low/sell high strategy, you could sell some stocks before a year has lapsed and pay higher capital gains rates. And if you’re repeatedly selling a lot of shares in this accelerated time frame, you could face some unpleasant surprises when it’s time to file your taxes.
Clearly, the buy low/sell high approach has some major drawbacks. So should you ignore the price of a stock when you’re making buy or sell decisions? No – just look at more than the price. If you’re considering buying a stock whose price is low, try to find out why it’s low. If it’s a good company in the grip of a strong “bear” market, then a low price may indeed indicate a good bargain. But if a company’s stock price is low because its products are no longer competitive or the company itself is part of a declining industry, then “buying low” with the hopes of eventually reaping big profits probably doesn’t make much sense.
Make your investment decisions carefully. But until a crystal ball arrives, don’t try to stay one step ahead of the market – or you could fall far behind.