Should you time the market or follow buy-and-hold strategy?

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A large number of investors try to time the market, selling when it is about to fall and buying ahead of a rally. But unless your middle name is Lucky, it’s virtually impossible to time the market perfectly. Instead, here’s what you should do.

As the stock market turns choppy, investors are exchanging nervous looks, and understandably so. No one wants to lose money in the market, especially after a fabulous rally like what’ve we had since the middle of May last year.

Depending on how edgy the investor is, they will start selling the moment the market catches a cold. Then, there are some, who will passively watch as their gains are bled by deep gashes in the hope that the market will revive after every fall. Both are sub-optimal approaches. Trying to time the market and, in contrast, employing a passive, buy-and-hold strategy both have their disadvantages, simply because of how the stock market works and your unique needs as an investor.

The first thing to know is that the economy–and, therefore, the stock market—has its own cycles. Like a runner, it keeps on running until it is out of breath. Then, it takes a break, regains its strength and starts running again until…Well, you get the picture. There are supercycles spanning several decades and regular cycles that happen within a decade. While theoretically one could time the start and end of these major and minor cycles, in reality they don’t occur with predictable starts and ends. More often, they become visible only in hindsight.

How an investor should approach the market is, then, dependent on their unique circumstances. That said, there are some general rules that could potentially help you in earning decent returns. The rules I am about to list are personal to me because they come out of my investing mistakes and experiences. Needless to say, someone else with a totally different success rate may have totally different rules to recommend. But if you are like me—reasonably aware and more focused on reasonable, but consistent, returns–then the following rules should suffice.

The first rule to taking luck out of investing is to invest only in high-quality stocks. There are a number of characteristics of a high-quality company, but let me just name a few: A) good management; staffed by competent professionals who want to do right by their investors. B) a well-defended business that makes it hard—ideally, impossible—for competitors to displace it in the market place. C) a strong balance sheet with healthy financial ratios, which will give the business the strength to withstand sudden shocks in the economy. D) a nimble company that constantly innovates to stay relevant as technology/market changes.

The other rule I would suggest is, don’t be a passive investor. While there’s enough evidence to show that the buy-and-hold strategy always works in the long term, it may not be enough to meet your unique situations in life.

For example, the need to invest in a new/larger house, getting a child married, or educated abroad. A lot of people will tell you to always cut your losses, but never your profits. That means, you never sell a rising stock prematurely, but get quickly out of one that is rapidly falling. Again, it is never easy to tell what is going to keep rising and what is going to fall quickly. The best you can do is stay focused on your financial goals. If a major expense is coming up, then you need to sell no matter what. If you are approaching retirement, then you do need to move a substantial part of your corpus to fixed income so that your future income is not in danger. Therefore, do what is appropriate for your situation in life.

The final rule I would recommend is to consider index investing if you don’t have the time or the appetite to be an active investor. The advantages are two-fold: one, your returns will be consistent with market returns and, two, your cost of investing will be lower, since index funds are typically cheaper to invest in.

Remember, your financial well-being is your responsibility. Don’t delegate that to someone else.