Author Topic: Theory of "set it and forget it" with stocks...  (Read 4075 times)

cbr shadow

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Theory of "set it and forget it" with stocks...
« on: November 12, 2013, 03:34:55 PM »
I understand "you can't time the market" for the most part, but here's what I dont understand..

I invest my Roth IRA in VTSAX (Admiral Stock Index through Vanguard) since I know in the long term it will trend upwards, and history shows that there's something like a 8% return over a long period of time even after big ups and downs.

This past year I had a 26% increase - WOW!  Just a good year for the market I guess.
You can't time the market, so keep your money there...  But history shows a 8% gain over time, and I've gained 26% in a single year.  Safe to say that this will average out over the next several years with there being losses or very very small gains to average back to 8%?

I'm not planning on moving my money because I'm sure there's a logical answer to my above question, I just dont know what that answer is.  The alternative would be to move money from stock index to a bond index until the market takes a hit and then move back.  Clearly this is timing the market, but why not do this in this situation?

Bruised_Pepper

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Re: Theory of "set it and forget it" with stocks...
« Reply #1 on: November 12, 2013, 03:39:55 PM »
I understand "you can't time the market" for the most part, but here's what I dont understand..

I invest my Roth IRA in VTSAX (Admiral Stock Index through Vanguard) since I know in the long term it will trend upwards, and history shows that there's something like a 8% return over a long period of time even after big ups and downs.

This past year I had a 26% increase - WOW!  Just a good year for the market I guess.
You can't time the market, so keep your money there...  But history shows a 8% gain over time, and I've gained 26% in a single year.  Safe to say that this will average out over the next several years with there being losses or very very small gains to average back to 8%?

I'm not planning on moving my money because I'm sure there's a logical answer to my above question, I just dont know what that answer is.  The alternative would be to move money from stock index to a bond index until the market takes a hit and then move back.  Clearly this is timing the market, but why not do this in this situation?


Because you don't know what's going to happen.  What if your current portfolio gets another year of 26% (hell, even 10-15%) growth but you're stuck with a portfolio of bonds because you switched anticipating a fall?  People who have way more experience with markets and who keep up to the second on all business/economy news have tried to time the market and very few (if any) have proven that they can beat the market consistently (i.e. without getting kind of lucky).

EDIT: And if you could earn a slight amount of return above market by timing and trading (even after all the transaction fees), is it worth it to spend hours and hours researching to achieve this?  What's especially good about index funds is that you generally get a respectable return with almost no effort whatsoever. 
« Last Edit: November 12, 2013, 03:43:56 PM by Bruised_Pepper »

mpbaker22

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Re: Theory of "set it and forget it" with stocks...
« Reply #2 on: November 12, 2013, 03:41:28 PM »
Simply put, timing the market does worse than the market.

You're thinking it's up 25% so why not drop out and buy after it falls 10%.  But what if instead of falling 10% it stays at 0% gain the next 3 years followed by a 20% rise.  Or what if it goes up another 25% and then stays at 0% gain for the 3 years after?  In both of those scenarios you would be worse off ...

Jamesqf

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Re: Theory of "set it and forget it" with stocks...
« Reply #3 on: November 12, 2013, 04:15:12 PM »
The alternative would be to move money from stock index to a bond index until the market takes a hit and then move back.  Clearly this is timing the market, but why not do this in this situation?

Would  the bond fund be a better investment today?  That is, if you were sitting on a pile of cash right now, where would you invest it?

Then figure that if you do sell stock (or stock fund), you'll have to pay capital gains on the profit.


dadof4

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Re: Theory of "set it and forget it" with stocks...
« Reply #4 on: November 12, 2013, 04:19:02 PM »
This past year I had a 26% increase - WOW!  Just a good year for the market I guess.
You can't time the market, so keep your money there...  But history shows a 8% gain over time, and I've gained 26% in a single year.  Safe to say that this will average out over the next several years with there being losses or very very small gains to average back to 8%?
Who's to say it hasn't already "averaged out"?  In fact, if you look at returns of this fund since 2007 (ie before the 2008 crash), your returns are lower than 8% - they're only 4%. So shouldn't you expect it to "average out" and up toward 8%?

The market is very hard (read impossible) to time with any level of certainty or accuracy. For every guy who tells you he had a feeling and sold his stock just before the crash, you'll get another guy who had a feeling, sold his stock, then saw it continue to rise.

Lans Holman

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Re: Theory of "set it and forget it" with stocks...
« Reply #5 on: November 12, 2013, 04:38:09 PM »
What you are saying is really just another version of the Gambler's Fallacy.  "Black has come up three times in a row, therefore red is due."  That 26% already happened.  It doesn't exert some magical pull upon the future.

Vanguards and Lentils

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Re: Theory of "set it and forget it" with stocks...
« Reply #6 on: November 12, 2013, 05:45:01 PM »
Gambler's fallacy does not apply here:

http://en.wikipedia.org/wiki/Gambler%27s_fallacy

The events "how the market performs today" are not independent

Lans Holman

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Re: Theory of "set it and forget it" with stocks...
« Reply #7 on: November 12, 2013, 05:51:37 PM »
Gambler's fallacy does not apply here:

http://en.wikipedia.org/wiki/Gambler%27s_fallacy

The events "how the market performs today" are not independent

True, there's more connection between how the market perfomed yesterday and how it's going to do today than there is between two spins of the wheel.  I would still maintain that if you convince yourself that the fact that it's been going up for some amount of time is enough to allow you to predict that it's now going to go down, absent any other information, you still have a version of that mentality. 

mpbaker22

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Re: Theory of "set it and forget it" with stocks...
« Reply #8 on: November 13, 2013, 10:31:29 AM »
Gambler's fallacy does not apply here:

http://en.wikipedia.org/wiki/Gambler%27s_fallacy

The events "how the market performs today" are not independent

True, there's more connection between how the market perfomed yesterday and how it's going to do today than there is between two spins of the wheel.  I would still maintain that if you convince yourself that the fact that it's been going up for some amount of time is enough to allow you to predict that it's now going to go down, absent any other information, you still have a version of that mentality.

The idea is similar, but your original post shows that you are thinking in terms of independent events.

I believe I would refer to the stock market returns each year as dependent events with unknown correlation.  In effect, it's nearly the same thing, but technically not gambler's fallacy.

grmagne

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Re: Theory of "set it and forget it" with stocks...
« Reply #9 on: November 13, 2013, 11:18:36 AM »
This page has a nice summary of historical rates of return by index.

http://www.1stock1.com/1stock1_142.htm

Before looking at the link, try this thought experiment.  You're invested in a fund that tracks the Dow Jones industrial average.  Your last 3 annual rates of return have been 2.1%, 33.4%, 26.0%.  When should you decide to time the market?  Now?  Next year?

....

With 20/20 hindsight the answer is wait 3 more years then invest in GICs for the next 9 years, but raise your hand if you knew that pre-dot-com bubble bursting:

1994  2.14%
1995  33.45%
1996  26.01%
1997  22.64%
1998  16.10%
1999  25.22%
2000   -6.18%

Oh the 1990s, what a time to be an investor :)
« Last Edit: November 13, 2013, 11:21:42 AM by grmagne »

Jamesqf

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Re: Theory of "set it and forget it" with stocks...
« Reply #10 on: November 13, 2013, 11:29:19 AM »
I would still maintain that if you convince yourself that the fact that it's been going up for some amount of time is enough to allow you to predict that it's now going to go down, absent any other information, you still have a version of that mentality.

True, but we generally do have other information, as for instance P/E ratios that can suggest whether stocks are realistically valued.  Of course the market may still continue to rise, but that suggests it's entering bubble territory, and is likely to experience a sharp correction.  Likewise, if prices have recently crashed and P/E ratios are low, it might be a good time to buy.

Even so, I don't think selling is really a good idea (due to capital gains tax), unless you have some better use for the money, such as a downpayment for a house.  For me, it's more of a guide to where I should be putting new money.  And I have shifted to putting a couple of hundred extra on each mortgage payment, rather than stuffing it all into stocks.