Can you time the market? Does it make sense to try?
More than two years ago, we launched a series of articles that examined those questions. We put to the test the assumption by numerous investors that because interest rates were at historic lows, they were poised to rise. Wait for the uptick, the thinking went, and you will reap the rewards.
So we analyzed two hypothetical investors. They both had $100,000 to invest in bonds, but took very different approaches. Investor A invested his $100,000 immediately. Investor B opted to park his funds in a tax-free money market, where he would earn 2.25%, while waiting for interest rates to rise.
Then rates fell
We all know what followed. Interest rates did not rise as expected. In fact, long-term rates declined while short-term money-market rates plummeted. Investors who unwittingly accepted “income risk” while attempting to avoid “market risk” were punished.
By Oct 2003, Investor A had received $14,000 from his 5.60% bonds while Investor B earned an average of .9% in his money market, or $2,250.
Although Investor B knows he made a bad decision 2 ½ years ago, he probably doesn’t realize that even if he was able to buy AAA-insured munis today at 6.00%, it would take more than 29 years to catch up to Investor A.
We aren’t sure why, but it seems that the longer interest rates remain low, the more convinced people become that they will imminently rise. That’s why we created Investors C and D in June 2002.
Investor C bought AAA-insured bonds yielding 5.00%, while Investor D stowed his $100,000 in the money market and, just as Investor B before him, waited for rates to rise.
In the ensuing 16 months, Investor C earned $6,666.66 while Investor D earned $433.33 – $6,233.33 less than Investor C. Even if Investor D’s dream came true and he could buy bonds yielding 6.00% today, it would still take 6.2 years to catch up to Investor C.
Waiting is costly, yet invisible to most
We analyze these scenarios because many investors don’t realize how costly it can be to wait for higher interest rates. Joe Mysak, a long-time bond market reporter for Bloomberg, illustrated this concept recently, and contrary to the vast majority of media, he had a very simple yet insightful analysis. Just do the math, he counsels, and the answers are obvious.
Many investors tell us that they leave their funds in money market accounts because they are not ready to “make a decision today.” But not making a decision is, in fact, a decision, and when you analyze the true cost of this choice, it can be an expensive one.