Question about market timing the current market

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LITeacher
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Question about market timing the current market

Post by LITeacher » Mon Aug 14, 2017 7:44 pm

Hi all,

I am far below average with regards to knowledge in personal finance when compared to the others here on the forum, though I know enough to know that market timing rarely works and is very anti-Boglehead. I happened to mention my allocation to my brother the other day, and he had made a point that I simply didn't know how to respond to, and I was curious if someone could work out the math behind his strategy and why it is not a good one.

Just a little preface to my question, he has a two comma investment portfolio and is 41. I am 31, ten years younger, and have an investment portfolio around 180K. While I may be focusing on growth versus his preservation, he was saying that I should be using the same strategy as he is using because it is basically a sure way to have a higher return.

Here's what he said---- We were talking about allocations the other day, and I had said I was at 85/15. He is at 50/50, and he said he didn't know why I was at 85/15 when it is inevitable the market will crash. He said as the market goes down, he will start to buy cheaper shares with the 50% that is not invested. He will put a little in at a time since of course he doesn't know where the bottom will be, but it will inevitably be cheaper than the shares that are priced today. He plans to then eventually end maybe somewhere in the realm of 65/35 or 70/30.

I told him market timing never works yada yada yada, and he basically said, "mathematically, how could it not work in this case? I have 50% of my portfolio in the market in case it continues to increase, and the other 50% I plan to invest back into the market as it starts to come down. I am bound to purchase cheaper shares than if I just leave them all in there today at the peak of the market."

Can someone mathematically explain why his logic is faulty? And though I am fine sleeping at night with an 85/15 portfolio, I can't say this didn't tempt me from selling some stocks and buying when the market starts to go down.
Thanks!
Last edited by LITeacher on Mon Aug 14, 2017 8:56 pm, edited 1 time in total.

Finance-MD
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Re: Question about market timing the current market

Post by Finance-MD » Mon Aug 14, 2017 7:54 pm

When he gets to 65/35 or 70/30, what is he going to do?
Will he let it go back down as he thinks the market is heating up just to do this again?

If he were 50/50 and planning to stay that way, that's great... you said that he of course won't know where the bottom is. Same goes for the top. Pick an AA and ride it up and ride it down... once he takes risk off the table.. he shouldn't be trading to put it back. That's market timing.

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Alexa9
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Re: Question about market timing the current market

Post by Alexa9 » Mon Aug 14, 2017 7:54 pm

There is no way to predict the future accurately. If there was, we'd all be rich. 50/50 is not a bad idea with the market at all time highs but there is no way of telling when you are at a peak. The key is to not panic when the market does drop and become more conservative as you get older. The most important thing is your consistent savings rate, not whether you average 1-2% more. Don't panic, set your investments on autopilot and ignore the noise.

alex_686
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Re: Question about market timing the current market

Post by alex_686 » Mon Aug 14, 2017 7:55 pm

LITeacher wrote:
Mon Aug 14, 2017 7:44 pm
He is at 50/50, and he said he didn't know why I was at 85/15 when it is inevitable the market will crash. ... "mathematically, how could it not work in this case?"
Can you tell us why he thinks that? The most common reasons given are 1. the length of bull run or 2. the high P/E ratios. Sadly neither one offers any predictive power in the mathematical sense. I can pull academic articles that run the math forwards and backwards.

LITeacher
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Re: Question about market timing the current market

Post by LITeacher » Mon Aug 14, 2017 7:57 pm

Finance-MD wrote:
Mon Aug 14, 2017 7:54 pm
When he gets to 65/35 or 70/30, what is he going to do?
Will he let it go back down as he thinks the market is heating up just to do this again?

If he were 50/50 and planning to stay that way, that's great... you said that he of course won't know where the bottom is. Same goes for the top. Pick an AA and ride it up and ride it down... once he takes risk off the table.. he shouldn't be trading to put it back. That's market timing.
I think when he gets to 70/30 he is then going to stay there. That was his allocation until recently, but now he went to 50/50 so he can buy back to 70/30 as the market falls.

LITeacher
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Re: Question about market timing the current market

Post by LITeacher » Mon Aug 14, 2017 7:58 pm

alex_686 wrote:
Mon Aug 14, 2017 7:55 pm
LITeacher wrote:
Mon Aug 14, 2017 7:44 pm
He is at 50/50, and he said he didn't know why I was at 85/15 when it is inevitable the market will crash. ... "mathematically, how could it not work in this case?"
Can you tell us why he thinks that? The most common reasons given are 1. the length of bull run or 2. the high P/E ratios. Sadly neither one offers any predictive power in the mathematical sense. I can pull academic articles that run the math forwards and backwards.
He said that the biggest reason he thinks that is because there are companies (I think he said Proctor and Gamble) with little to no innovation that are trading at record highs or something? I forget what he said exactly - something like that though.

Basically he thinks the market is at a peak and near the end of the bull run

Elbowman
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Re: Question about market timing the current market

Post by Elbowman » Mon Aug 14, 2017 8:03 pm

LITeacher wrote:
Mon Aug 14, 2017 7:44 pm
I am bound to purchase cheaper shares than if I just leave them all in there today at the peak of the market.
Well, there's one error at least. How is he "bound" to purchase cheaper shares? It's completely possible that the market will steadily increase for the next decade, and will never again be as cheap as it is right now.

delamer
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Re: Question about market timing the current market

Post by delamer » Mon Aug 14, 2017 8:04 pm

Your brother is ignoring that about 1/3 of the S&P 500 total return is from dividends, so he missing out on a significant portion of the return when he keeps assets out of the market.

venkman
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Re: Question about market timing the current market

Post by venkman » Mon Aug 14, 2017 8:07 pm

LITeacher wrote:
Mon Aug 14, 2017 7:44 pm

I told him market timing never works yada yada yada, and he basically said, "mathematically, how could it not work in this case? I have 50% of my portfolio in the market in case it continues to increase, and the other 50% I plan to invest back into the market as it starts to come down. I am bound to purchase cheaper shares than if I just leave them all in there today at the peak of the market."

Can someone mathematically explain why his logic is faulty? And though I am fine sleeping at night with an 85/15 portfolio, I can't say this didn't tempt me from selling some stocks and buying when the market starts to go down.
Thanks!
The problem is that he's giving up the higher return on stocks for as long as the bull market lasts. The market may drop by 20% three years from now, but it may go up by 40% before that drop happens, in which case you would still have a net gain compared to today's prices.

The other problem is how do you know what the inevitable market crash will look like? It might be a 20% drop in a week; it might be a 20% decline over 3 years. Ask your brother how far the market will have to drop before he starts buying in.

The OTHER other problem is that, while stocks are certainly overvalued by historical measures, the correction may not be in the form of a crash--it may be in the form of historically low (say, 3-4%) average annual returns over the next decade. There may never be an opportunity to buy in at a discount.

The OTHER other other problem is that part of the reason stocks have such high valuations is that bond valuations are even HIGHER. Low bond yields lead more investors to get into stocks. Stocks will become a less attractive investment when bonds become a more attractive investment; and for that to happen, bond prices will have to drop significantly. If you're truly a fan of market timing, bonds are not an ideal place for your money right now.

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CyclingDuo
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Re: Question about market timing the current market

Post by CyclingDuo » Mon Aug 14, 2017 8:07 pm

LITeacher wrote:
Mon Aug 14, 2017 7:44 pm
Hi all,

I am far below average with regards to knowledge in personal finance when compared to the others here on the forum, though I know enough to know that market timing rarely works and is very anti-Boglehead. I happened to mention my allocation to my brother the other day, and he had made a point that I simply didn't know how to respond to, and I was curious if someone could work out the math behind his strategy and why it is not a good one.

Just a little preface to my question, he has a two comma investment portfolio (probably in the realm of 5M?) and is 41. I am 31, ten years younger, and have an investment portfolio around 180K. While I may be focusing on growth versus his preservation, he was saying that I should be using the same strategy as he is using because it is basically a sure way to have a higher return.

Here's what he said---- We were talking about allocations the other day, and I had said I was at 85/15. He is at 50/50, and he said he didn't know why I was at 85/15 when it is inevitable the market will crash. He said as the market goes down, he will start to buy cheaper shares with the 50% that is not invested. He will put a little in at a time since of course he doesn't know where the bottom will be, but it will inevitably be cheaper than the shares that are priced today. He plans to then eventually end maybe somewhere in the realm of 65/35 or 70/30.

I told him market timing never works yada yada yada, and he basically said, "mathematically, how could it not work in this case? I have 50% of my portfolio in the market in case it continues to increase, and the other 50% I plan to invest back into the market as it starts to come down. I am bound to purchase cheaper shares than if I just leave them all in there today at the peak of the market."

Can someone mathematically explain why his logic is faulty? And though I am fine sleeping at night with an 85/15 portfolio, I can't say this didn't tempt me from selling some stocks and buying when the market starts to go down.
Thanks!
Your brother has "won the game" so to speak. Therefore, his capital preservation is understandable at $5M. So 50/50 for him as he waits for his "bottom call" is his personal preference.

You have time, and the power of compounding on your side. Keep contributing on a monthly basis through thick and thin for another three decades. It's the savings rate that wins the game. That and the reinvested dividends. The goal is to get the return of the market. Even if the historical averages out to 7% per year, your money will double every 10 years at that rate. To time the market, you have to do it more than once. Both on the sell, and on the buy. And you must pay the capital gains while you are at it for any investments in taxable accounts. Recessions/bear markets, expansions/bull markets are all part of the journey. Those that think they can time it perfectly - best of luck.

What if you only bought at market peaks?

http://awealthofcommonsense.com/2014/02 ... ket-timer/

alex_686
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Re: Question about market timing the current market

Post by alex_686 » Mon Aug 14, 2017 8:07 pm

LITeacher wrote:
Mon Aug 14, 2017 7:58 pm
alex_686 wrote:
Mon Aug 14, 2017 7:55 pm
LITeacher wrote:
Mon Aug 14, 2017 7:44 pm
He is at 50/50, and he said he didn't know why I was at 85/15 when it is inevitable the market will crash. ... "mathematically, how could it not work in this case?"
Can you tell us why he thinks that? The most common reasons given are 1. the length of bull run or 2. the high P/E ratios. Sadly neither one offers any predictive power in the mathematical sense. I can pull academic articles that run the math forwards and backwards.
He said that the biggest reason he thinks that is because there are companies (I think he said Proctor and Gamble) with little to no innovation that are trading at record highs or something? I forget what he said exactly - something like that though.

Basically he thinks the market is at a peak and near the end of the bull run
Such an argument would suggest big fat dinosaurs of oligopolies will rule the earth in the future. I think that is a valid line of thought. However the people I read suggest that his will lock in the current winners. Think fat profits and a high moat. With little competition the risk will be low, low risk implies a high P/E ratio. So I would argue that from this point forward we should be seeing low constant returns. Lets say the stock market will deliver real returns somewhere in the 3% range. I can make a solid mathematical argument for that. For more thoughts see the thread "Index Funds are evil", about a world of low competition.

viewtopic.php?f=10&t=225309

jbolden1517
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Re: Question about market timing the current market

Post by jbolden1517 » Mon Aug 14, 2017 8:36 pm

The approach he is talking about is called Tactical Asset Allocation (TAA). There is no reason it can't work. There are successful TAA investors and funds. In general though most individuals who try TAA underperform the funds the are TAAing in and out of by many percentage points.

The way I look at it is this. There are bear markets all over the planet. There are good valuations all over the planet. USA bears are way scarier than foreign country bears and industry / sector bears. If you are too iffy to buy into foreign bears and sector / industry bears you are unlikely to actually buy into a deep USA bear. Timing is hard, it is not impossible. So sorry no proof. My advice though would be that if he wants to do TAA, buy a TAA fund or use a TAA robo-advisor. The odds are against him.

avalpert
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Re: Question about market timing the current market

Post by avalpert » Mon Aug 14, 2017 8:40 pm

LITeacher wrote:
Mon Aug 14, 2017 7:58 pm
alex_686 wrote:
Mon Aug 14, 2017 7:55 pm
LITeacher wrote:
Mon Aug 14, 2017 7:44 pm
He is at 50/50, and he said he didn't know why I was at 85/15 when it is inevitable the market will crash. ... "mathematically, how could it not work in this case?"
Can you tell us why he thinks that? The most common reasons given are 1. the length of bull run or 2. the high P/E ratios. Sadly neither one offers any predictive power in the mathematical sense. I can pull academic articles that run the math forwards and backwards.
He said that the biggest reason he thinks that is because there are companies (I think he said Proctor and Gamble) with little to no innovation that are trading at record highs or something? I forget what he said exactly - something like that though.

Basically he thinks the market is at a peak and near the end of the bull run
Last year P&G spent over $2 billion on R&D - there is a lot of innovation going on there. Frankly, and with all due respect, your brother doesn't know what he is talking about and has no particularly insight into where the market it relative to where it will peak - if he did, he would have a lot bigger portfolio than $5m.

Having a 50/50 portfolio is perfectly reasonable if that matches your risk/return preferences - but it is mathematically expected to have lower returns than an 85/15 portfolio with lower risk - mathematically, there is no such thing as an 'inevitable market crash' and there is no way of knowing what he future trajectory will look like.

rgs92
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Re: Question about market timing the current market

Post by rgs92 » Mon Aug 14, 2017 8:47 pm

If I had a brother with 5 million dollars I would not argue with him and tell him he sure was smart.
And I'd be sure to send him a card and a nice present on his birthday and at Christmas and offer to do some pet sitting for him when he was on vacation.

LITeacher
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Re: Question about market timing the current market

Post by LITeacher » Mon Aug 14, 2017 8:52 pm

rgs92 wrote:
Mon Aug 14, 2017 8:47 pm
If I had a brother with 5 million dollars I would not argue with him and tell him he sure was smart.
And I'd be sure to send him a card and a nice present on his birthday and at Christmas and offer to do some pet sitting for him when he was on vacation.
Lol!

He got very lucky - was a C-level executive at a company that went public. His portfolio is mostly from the liquidation of those stocks.

deltaneutral83
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Re: Question about market timing the current market

Post by deltaneutral83 » Mon Aug 14, 2017 9:38 pm

LITeacher wrote:
Mon Aug 14, 2017 8:52 pm
rgs92 wrote:
Mon Aug 14, 2017 8:47 pm
If I had a brother with 5 million dollars I would not argue with him and tell him he sure was smart.
And I'd be sure to send him a card and a nice present on his birthday and at Christmas and offer to do some pet sitting for him when he was on vacation.
Lol!

He got very lucky - was a C-level executive at a company that went public. His portfolio is mostly from the liquidation of those stocks.
I guess my takeaway is that between 50/50 and 70/30 will have little effect on his status as having "won the game" with $5M at age 41, unless there is an out of the ordinary reason. This is the point the authors of the books suggested on BH want to make. It is suggested people examine more than the numbers in this scenario. Someone at $5m can use their time doing something more constructive rather than tinkering between 50/50 and 70/30 .

On a numbers analysis, people have been screaming about the big bad bear since 2013 and February 2016 headline elicited thoughts of Armageddon. There hasn't been anyone to prove they can time the market effectively over any meaningful time frame. You can also look at other bull markets and realize this one we are in is several years short of those.

AlohaJoe
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Re: Question about market timing the current market

Post by AlohaJoe » Mon Aug 14, 2017 9:44 pm

LITeacher wrote:
Mon Aug 14, 2017 7:44 pm
I told him market timing never works yada yada yada, and he basically said, "mathematically, how could it not work in this case?"
He clearly has never run the numbers and is hand waving. Mathematically he is wrong. There have been many many explanations with actual data showing how sitting out of the market "because a crash is inevitable" actually works out.

Here's a recent academic paper called "Bubbles for Fama" https://scholar.harvard.edu/files/shlei ... 170217.pdf
Second, as importantly, bubble peaks are notoriously hard to tell, and prices often keep going up, at least for a while, before they crash, leading to good net returns for an investor who stays all the way through. As Fama (2014, p. 1476) points out, Robert Shiller “called” the US stock price bubble in December 1996, and prices proceeded to double after that. At its low, in 2003, US stock price index was higher than when Shiller first called the bubble. In our data, we find that even of the 21 episodes in which a crash does occur ex post, on average prices peak 6 months after we first identify the industry as a potential bubble candidate. The average return between the first identification of the price run-up and the peak price is 30%, confirming the adage that it is difficult to bet against the bubble, even if one can call it correctly ex ante.

sambb
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Re: Question about market timing the current market

Post by sambb » Tue Aug 15, 2017 4:40 am

your brother may be correct. if a bear market comes soon, then he will be right. mathematically it depends on a bear coming soon v. continued bull.

LITeacher
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Re: Question about market timing the current market

Post by LITeacher » Tue Aug 15, 2017 8:46 am

Great reading!!! I sent him some of these in an email and he ended up sending it to his advisor since he probably didn't know how to respond.

The advisor attached an article as a response:

http://heathcoteinvestment.com/wp-conte ... ls-Ju-.pdf

I skimmed through it but I wasn't seeing the relevant point to market timing.

Da5id
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Re: Question about market timing the current market

Post by Da5id » Tue Aug 15, 2017 8:50 am

The sad part is the brother could easily be correct (or not of course). But if he is correct, and market crashes in next few months, he'll now take the lesson that he understands the market far more than he actually does. This works kind of like people remembering their gambling winnings more than losses and thinking they are up overall...

NotWhoYouThink
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Re: Question about market timing the current market

Post by NotWhoYouThink » Tue Aug 15, 2017 8:54 am

Oh no! Not another dividend growth thread!

Also, market timing sometimes works. All gamblers don't lose every game, some lottery tickets pay out, some market timers clean up. It's not the way I'd bet, but never is much too strong a word.

LITeacher
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Re: Question about market timing the current market

Post by LITeacher » Tue Aug 15, 2017 9:01 am

[quote=NotWhoYouThink post_id=3493334 time=1502805253 user_id=59479]
Oh no! Not another dividend growth thread!

Also, market timing sometimes works. All gamblers don't lose every game, some lottery tickets pay out, some market timers clean up. It's not the way I'd bet, but never is much too strong a word.
[/quote]

What is the advisor's argument with the dividend growth article?

Jack FFR1846
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Re: Question about market timing the current market

Post by Jack FFR1846 » Tue Aug 15, 2017 9:08 am

Maybe I'm wrong, but I think your brother is talking about simple rebalancing. He can do that with 50/50 and you can do it with 85/15. Pretty simple. If you update a spreadsheet with all of your investments and see that you're going more than 5% outside of your desired allocation, you simply sell-to-buy in your tax advantaged account, where you hold all asset classes. This essentially replaces overpriced assets with underpriced assets. Target Date funds do this on a daily basis. Others do this on quarterly, annual time periods or watch for the bands to exceed some percentage (I mentioned 5% above). This is quite different from market timing, where you sit in cash and wait to buy something then sell when you think it's high. You're setting an asset allocation and rebalancing to keep it where you want it.
Bogle: Smart Beta is stupid

jbolden1517
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Re: Question about market timing the current market

Post by jbolden1517 » Tue Aug 15, 2017 9:09 am

LITeacher wrote:
Tue Aug 15, 2017 8:46 am
Great reading!!! I sent him some of these in an email and he ended up sending it to his advisor since he probably didn't know how to respond.

The advisor attached an article as a response:

http://heathcoteinvestment.com/wp-conte ... ls-Ju-.pdf

I skimmed through it but I wasn't seeing the relevant point to market timing.
It isn't. The pamphlet is making the case for an actively managed internationally tilted dividend growth fund (or direct holdings). It isn't making the case for TAA at all. He isn't listening to his advisor either, or his advisor didn't bother to read the pamphlet himself. DNL IMHO is a far better way to get that for a lot less money.

FWIW Merrill is rather expensive as an advisor. I'd say that's potentially an even bigger problem though hard to know. If he is willing to pay those kinds of fees Larry Swedroe's group is both cheaper and better: http://buckinghamadvisor.com/ That might be the best thing to point him too if he is interested in listening to you at all.

alpha88
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Re: Question about market timing the current market

Post by alpha88 » Tue Aug 15, 2017 9:18 am

In my (humble) opinion- this really isn't market timing. Right now, I think he has a very reasonable asset allocation for preservation. I think given his circumstances, he's investing wisely.

If the stock market does drop dramatically (say 30+% drop), and THEN he increases his equity exposure, THAT would be market timing, and I think potentially risky as he certainly has no ability to determine when it's going to go back up.

LITeacher
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Re: Question about market timing the current market

Post by LITeacher » Tue Aug 15, 2017 9:24 am

alpha88 wrote:
Tue Aug 15, 2017 9:18 am
In my (humble) opinion- this really isn't market timing. Right now, I think he has a very reasonable asset allocation for preservation. I think given his circumstances, he's investing wisely.

If the stock market does drop dramatically (say 30+% drop), and THEN he increases his equity exposure, THAT would be market timing, and I think potentially risky as he certainly has no ability to determine when it's going to go back up.
That is his plan though- to increase equity exposure to 70% from 50% when the market declines.

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Re: Question about market timing the current market

Post by pkcrafter » Tue Aug 15, 2017 10:08 am

LITeacher, first and foremost: yes, the market will fall, but when and how far we just don't know. With timing you have to be right about when it will fall, how much it will fall, when it will recover, and how much it will recover. That's a very tough order to fill.
That is his plan though- to increase equity exposure to 70% from 50% when the market declines.
How is brother going to know when the market has hit it's low? What if he waiting for a 20% drop and it only drops 10%? Lots of investors have reduced equity allocation only to be below target AA for years because the market did not act as they expected. It's not a game worth playing.

Secondly, both you and your brother have forgotten that while you are at 85% stock, if/when the market drops and your portfolio drops to 80% equity, you will have to rebalance by transferring money from non-stock (bonds/cash) into stocks to get your AA back to target. If the market continue to drop you will have to do it again. No timing involved, just keeping asset allocation on target. But the outcome is the same, you will also be buying at lower prices.

By the way, at 31, your saving/accumulation rate is far above average. Just understand your AA is quite aggressive, and bad market falls can be very scary if you have no experience with them.


Paul
When times are good, investors tend to forget about risk and focus on opportunity. When times are bad, investors tend to forget about opportunity and focus on risk.

jbolden1517
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Re: Question about market timing the current market

Post by jbolden1517 » Tue Aug 15, 2017 10:28 am

LITeacher wrote:
Tue Aug 15, 2017 9:01 am
t with the dividend growth article?
The argument in the pamphlet is
a) Stocks have a real intrinsic value given by the Gordon formula: http://www.investopedia.com/terms/d/ddm.asp . This is correct.

b) Given a regime of low real interest rates likely to persist investors seeking both safety and reasonable returns will have no choice but to look to dividend stocks that are high on quality metrics. This is a reasonable opinion that might be true. There are many alternative ways this could play out. Your brothers theory of a sudden spike in returns (a crash) is another way this could play out. This is important your brother and that pamphlet don't agree.

c) There are two types of dividend strategies:
i) high dividend where you draw from companies that are often slowly shrinking and compound yields quickly
ii) a dividend growth strategy where you invest in companies that are growing their dividends.
The pamphlet didn't make the case the (i) over (ii) though it is not unreasonable for your brother regardless

d) The international dividend growth investing strategy is less developed internationally than in the USA. This statement as written is to vague to evaluation but to oversimplify I think this is likely false.

e) As a consequence an active stock picking formula is likely to outperform a passive strategy like S&P Global Dividend Aristocrats. Well two comments. First I'm not sure that's the only type of passive strategy one should be considering. While it is a rather good one it is not representative and further can be quite expensive to implement. Second, they never really make a case for what the active fund will be doing differently than a corresponding passive fund.

Anyway, big point is none of this agrees with your brother. It is an entirely different philosophy than his.

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