Blogs > Your Money

Dave Patterson and Erin Preston, a father-daughter team of Certified Financial Planner® licensees, provide thoughts and suggestions on a broad collection of personal finance topics.  Information provided in this BLOG is intended to be of a general nature and may not be appropriate for all situations.  Readers should consult with their own financial advisors before relying on any information contained herein.

Monday, January 10, 2011

An Example of Why It’s Tough to Time the Market

Many investors think they can time the general market or even specific sectors or asset classes. We’ve written time and time again about how difficult market timing is. You have to be right twice. You have to know when to get out of the market and then when to get back in. Being right in one of those instances is tough. Being right in both instances is really tough.

Over the last two years we’ve seen an exceptional drop in residential real estate prices, with nearly unprecedented numbers of foreclosures. Many predict more foreclosures in 2011 than in 2010. There has been some worry about commercial real estate, as well. While commercial real estate may not have been severely impacted in some parts of the country, in Michigan, wherever you go, you see empty offices, factories and stores.

It’s seems natural then, that investors should have shunned any type of investment related to real estate for the last two years. Many of our clients have, in fact, resisted investments in the real estate asset class and some have pushed us to sell their real estate holdings. We stood firm, however, and urged them to maintain their target portfolio real estate percentage, either buying or selling, depending on whether or not they were under-allocated or over-allocated, respectively, in the real estate asset class.

So what happened with real estate investments the last two years? A recent article in the Wall Street Journal titled “Real Estate Outruns the Stock Market Again” by A.D. Pruitt (Wednesday, December 29, 2010), noted that real estate stocks were “poised to end the year with gains that are twice as large as the broader stock market”.

The article went on to say: “REITs (Real Estate Investment Trusts), as measured by the Dow Jones All REIT index, were up 27% as of Tuesday’s close. While that is a smaller gain than last year, when REITS posted gains of 28.5%, the 2010 results handily beat the DOW Jones Industrial Averages….”

So why, contrary to logical thinking, did REITs perform so well? It was due to investors’ desire for income. According to the article, REITs were returning dividend yields of about 4% versus a return of 3.35% for Treasury bonds. If one looked at REIT prices alone, they might have thought they were over-bought in 2009 and due for a correction. Yet the yield for REITs, compared to Treasuries spurred investors on to continue buying REITs.

You might argue, therefore that astute investors should have anticipated the continued rise. That may well be, but sometimes asset classes continue rising for reasons not easily explained. Sometimes investors chase past returns. It may be that investors continue to buy more REITs in 2011 because they’ve done so well the last two years. Then again, there may be a correction in REIT prices in 2011.

The best approach, we believe, is to establish targets for all of your portfolio asset classes and then periodically (at least annually) rebalance them by selling if you are over-allocated and buying more if you are under-allocated. You won’t hit the peaks and valleys - but by doing so you remove your emotions from the process. Rebalancing, if done in a disciplined manner, forces you to buy lower and sell higher than the typical market timer.


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