How NOT To Time A Correction

Aaron Hodson Jul 05, 2014

This article first appeared in the National Post, July 5, 2014. To see it in its original form, click here.

Record high markets have our customers asking us questions every day such as: When will there be a correction in the market? What can I do to protect myself from it?

First of all, this sort of thinking can be detrimental to your portfolio. Corrections are part of the market, just as rallies are.

Trying to predict a correction is more or less impossible, but it also automatically puts you in a defensive posture. If you are constantly watching for negative signs, there is a good chance many good stocks will pass right on by, because you won’t be attuned to their positive attributes.

As a result, correction watching is difficult and it can cost you serious money. Here are five other reasons why you shouldn't try to time a correction.

A correction isn't overdue just because markets are at record highs

Think of a coin toss: just because heads comes up 10 times in a row does not mean there is a change in the probability that tails will show up on the next toss.

Many investors make this mistake, and are of the view that there must be a correction soon. But markets do not follow any rules.

Sure, a correction could happen next week. Or a rally could keep going for months or years. The TSX once went up 11 months in a row. A bull market — if we are truly in one — can last for years. In markets, anything can happen, always.

You pay taxes if you sell

Correction watchers often forget that if you are sitting on gains in a taxable account, you have to pay capital gains taxes.

If you sell and re-buy later, you need to make about 23% just to cover the taxes lost. That is a fairly big expected return for any sector, at any time.

The problem of re-buying

Suppose you have successfully timed the top of the market and are now sitting in 100% cash. When are you going to start to buy? Do you wait for the market to go down 5%? 10%? 30%?

What’s more, are you going to be able to actually buy stocks if they are down 30% and everyone else is panicking? Do you have what it takes to go against the crowd?

A correction may not come

Suppose you are 100% in cash and the correction does not, in fact, occur. Do you wait six months before buying? One year? Five years? Will you be willing to buy stocks at higher prices than what you sold them for? Most investors are not.

Loss of dividend income

Going to cash, of course, means you won't get dividends as well as lose out on any upside potential.

Companies such as AltaGas Ltd. and Alaris Royalty Corp. continue to increase dividends on a regular basis, which is income you must be willing to forgo while you await the market correction (which may not come).

If you miss out on 4% in dividends while awaiting a 10% correction, you now need to be even more accurate in your timing just to break even.

We say forget the correction predictions. Keep a diversified portfolio of quality companies. The market will go up and down, but, over time, it goes up far more than it goes down.

Remember, no one — seriously — can predict what will happen next. Save on taxes and fees and let someone else worry about the looming correction.




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