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I RECENTLY WROTE about missing the chance to harvest tax losses. A reader decried this as market timing, which I found surprising. But on second thought, I can see where the reader was coming from.
Suppose we define market timing as any buy or sell decision that’s taken only when the time is right. Using this definition, I’m guilty as charged.
But if that’s the case, is all market timing bad? I’d argue it depends on the intent behind the action. Take the example of Tim, a fictitious investor with a 50% stocks-50% cash portfolio. Consider three scenarios.
Scenario 1: Tim wants to put more money into stocks, but he’s waiting for the market to drop. As the market drops a bit, he buys stocks with half of his cash. When the market dips further, he goes all-in.
Scenario 2: During his annual portfolio checkup, Tim notices that the recent bull market has inflated his stock allocation. He rebalances his portfolio, selling some stocks and thereby bringing his portfolio allocation back to 50-50.
Scenario 3: Tim notices during a down market that the stocks in his taxable account are trading below their original purchase price. To realize the tax loss, Tim sells the losing stocks and immediately buys others that give him similar market exposure.
One could argue that all three scenarios are market timing. The first scenario is an investment strategy that doesn’t work so reliably. The second scenario is a risk-management strategy to keep Tim’s portfolio aligned with his risk tolerance. The jury is still out on whether rebalancing also improves portfolio performance.
The third scenario is neither an investment strategy nor a risk-control strategy. There’s no material change in Tim’s market exposure, and hence no change in expected return or risk. It’s merely a tax-cutting strategy. The strategy is possible only if the market drops below a certain mark. It could indeed be considered a market-timing strategy, but it isn’t one to frown upon.
What is the problem with market timing? Is it one of those cardinal “sins” like stock-picking that we read about on here?
Market timing (reducing your withdrawal rate based on market performance) is precisely what the Guyton’s Guardrail withdrawal strategy for retirement is about. It is prudent risk management.
I think market timing is any investment decision based on a market forecast. I don’t consider steps like rebalancing, spending less amid a market decline or tax-loss harvesting to be market timing — because you aren’t forecasting market performance, but rather reacting to it.