The Illusion of the Perfect Wave

The sea roars menacingly beneath me. However, I stand completely relaxed on my board, with a low center of gravity, one united with the board. I surf perfectly along the wall of the wave.

Then I woke up, wet with sweat and not from the seawater. The perfect wave was merely a dream, never in my life have I glided across the sea like that.

However, the constant companion of many investors is a completely different dream. The dream of the perfect market wave. You surf the bull market up to the peak - as it is called in surfer jargon. Then, you sell all the your stock positions, lay low in money markets as the wave collapses and buy stocks to the max as the next wave builds up once again.

Supremacy in the jungle

Yet, we all know - dreams are dreams and reality looks very different. Let us stay with the sea, as the tides are a good comparison; there can be found a change of tides and ebbing in the markets. Bull and bear markets do alternate and neither of the two eponymous animals (bull and bear) equating to the rising and falling of the stock market can dominate the stock market jungle in the long run.

We investors do not want to be overrun by the bull or mauled by the bear. This view is much more important than trying to make the perfect entry and exit and thus avoiding wealth-destroying mistakes. A good first step for us to take: no extreme changes in equity exposure. Rather, let us find the equity allocation that we can sustain in times of crisis. Market timing - entering and exiting the market in time - does not work.

Coincidence is not repeatable

That does not mean it can never work. I well remember an investment firm that sharply reduced its equity exposure and added precious metals companies before the 2008-09 financial crisis. It performed much better than the benchmark of 50 percent stocks and 50 percent bonds in 2007, 2008 and 2009, a period when most others were sliding down into the deep valley with their positions.

What happened afterwards? Due to the success, the investment volume of the investment company increased tenfold and they were happy about correspondingly high management fees. The investors assumed that their manager would continue to perfectly exploit the waves on the markets in the future. Too high an expectation, as it turned out. For many years, the fund was far below the competition.

The lesson to be learned from this is that at every turning point someone gets the entry or exit exactly right. Statistically, this is completely logical. In a distribution of thousands of investment firms, a few must inevitably be favored by chance. However, the result is far from repeatable.

Avoiding big mistakes

I would like to sharpen my statement regarding market timing. Consistent market timing does not work. So what is the solution? An investor who can sustain 100 percent equities should never have less than 80 percent equities. An investor who is happy with an average of 60?percent stocks should never have less than 50 percent and never more than 70 percent.

With this simple rule, big mistakes can be avoided. Strong corrections within the stock markets are accompanied by strong emotions. If our emotional world is upside down, our ability to make decisions suffers. It is therefore advisable to define clear rules in advance.

If you think you can be successful with a wide range of zero to 100 percent of shares, you have to be prepared for a wipe out. That is what surfers call an involuntary fall from the board. At the Wipe Out Award, the most breathtaking exits are even nominated. Unfortunately, no prizes are awarded for this in the investment world. Even when surfing, you are not immune to serious injuries in the event of a fall. At least surfers and investors do shake hands in this regard.

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