The Distinction Between Market Timing & Threat Administration

A reader asks:

I’m a little bit behind and simply listened to ATC from 2/15 over the weekend. That is actually a query for Josh however he made a couple of feedback that left me confused. He scoffed on the thought of Ritholtz “market timing” in funding portfolios however then went on to clarify the commerce so as to add length in fastened revenue. However that that commerce wasn’t market timing and was simply “danger reward evaluation” of the completely different potential financial outcomes. I’m having some bother in my very own portfolio defining for myself when to make any tilts. I don’t wish to market time particular person shares or something in a short-term window as I agree these are extraordinarily tough. However making greater image asset allocation tilts primarily based on the financial system/enterprise cycle do appear prudent – how do you outline market timing and when any tilts to a long-term asset allocation are prudent/might be made with out it being thought-about “market timing”?

Honest query.

There’s a distinction between market timing and danger administration.

Market timing is about predicting.

Threat administration is about making ready.

Market timing assumes you recognize what’s going to occur sooner or later.

Threat administration assumes you don’t know what’s going to occur sooner or later.

Market timing is for individuals who suppose they’re smarter than the market.

Threat administration is for individuals who know they’re not.

I’m on my agency’s funding committee. Our decision-making course of seems on the previous but in addition considers the risk-reward trade-off within the current.

As an illustration, we don’t attempt to predict the path of rates of interest. Nobody can do that — not the Fed, not bond fund managers, not pundits on monetary tv — nobody. There are far too many variables at play — inflation, financial progress, investor choice for yield, central financial institution intervention, and many others.

However we will assess the present degree of yield in relation to the danger and reward inherent within the varied bond devices.

When bond yields throughout the Treasury yield curve fell beneath 1% throughout the pandemic panic, taking length danger in bonds made no sense. The draw back far outweighed the upside. So we moved to ultra-short length bonds.

That wasn’t an implicit prediction that charges had been going to rise. We had no thought charges would go from 0% to five% in such a brief time frame, wreaking havoc on bonds. That was a risk-reward trade-off resolution the place you weren’t being compensated in yields commensurate with the extent of potential draw back if charges had been to rise.

And that was earlier than T-bills had been yielding 5%. We had been comfy investing in T-bills and short-duration bonds as a result of the rate of interest danger was a lot decrease. Now that intermediate-term bond yields are increased, that risk-reward equation seems quite a bit completely different.

That was an allocation change primarily based on market dynamics, not our means to forecast the longer term.

Market timing requires you to be proper twice — if you get out and if you get again in once more. We by no means had any illusions we may choose the underside or high in charges. It was extra about understanding the completely different bond devices and their potential upside and draw back primarily based on length, yield and credit score high quality.

Name it market timing if you’d like however that’s not the way in which I see it.

Rebalancing isn’t market timing. It’s a option to maintain your portfolio in alignment together with your said danger profile.

Altering your asset allocation as you age isn’t market timing. It’s prudent danger administration that considers the altering nature of danger as your time horizon modifications.

Taking kind of danger as your monetary circumstances change isn’t market timing. It’s excellent that your willingness, want and talent to take danger can and can change relying in your scenario.

Market timing is about outcomes.

Threat administration is about course of.

We spoke about this query on this week’s Ask the Compound:



Nick Maggiulli joined me once more on the present this week to debate questions referring to giving monetary recommendation to members of the family, the hire vs. purchase resolution, how onerous it’s to change into a millionaire and how you can diversify your portfolio as you age.

Additional Studying:
The Siren Music of Market Timing