401K Market Timing

Question

I was recently reading a question regarding protecting your 401K from stock market drops and I got me a bit more curious about timing the market.

We know that at some point there will be a large stock market drop when the next big issue/correction arises and based on my observations will almost certainly bottom out 2-5 years after that, but never sooner.

If I could correctly guess (within a small margin of error) where the peak was and shifted my 401K funds into something like a cash account (not withdrawing) and then shifted it all back into funds after a couple of years, is there a downside?

As I see it: If the market is near bottom when I move back in, I am getting in at the best time; if it still has three more years of falling, I would still be better off than I was had I kept it in. Is there something I'm not considering?

I understand that timing the market is difficult if not impossible. I'm just trying to figure out if there is a hidden cost to successfully doing this like a tax or penalty or something.

Answer 1

There is not a hidden cost or tax penalty in a tax advantaged account like your 401(k).

Something that you are not considering is the option of allocating a portfolio with other assets like US treasury bonds that tend increase during a stock market correction. If you rebalance your portfolio regularly you can come out even further ahead with lower risk.

The biggest risk of timing the market is missing out on the gains if the market moves up instead of down while your portfolio is all cash.

Answer 2

If I could correctly guess

You can't, that's the problem.

With this in mind, I keep a 10% allocation to the money market fund. When I feel the market has hit a correction, reallocate the cash in to the other positions. But I would really stay away from pulling funds out of the market. All it takes is missing something like the 10 biggest up days to completely miss the year's gain.

Answer 3

No, no hidden costs or tax consequences (other than transactions costs for your 401(k) if any). All transactions inside a 401(k) have no direct tax consequences. You are only taxed when you withdraw funds.

Good luck! :)

Answer 4

To some extent, investors do some timing either passively or actively. Some examples are buying perceived undervalued stock or selling overvalued stock, selling covered calls as an exit strategy, selling cash secured puts as an acquisition strategy, rebalancing, hedging, changing one's equity/fixed income ratio.

Timing the market as in predicting (or guessing) where the top is, is a fool's errand. But that doesn't mean that you can't protect your portfolio from decimation and anyone who says otherwise is probably someone who rode the market down all the way in 2000 and 2008 when it lost over 50% of it's value (I didn't).

There are many ways to protect your portfolio. Here's my two cents on various ways to do so: What to move investments to before a crash?

The simplest way to defend is to determine what percent of loss you are willing to incur before beginning a transition away from full market exposure. At that point, move some percent out of harm's way (5%? 10%? Whatever). If the market keeps dropping, wash, rinse, repeat. The worst that can happen is that you miss out on the upside on the re-allocated portion. That won't break you or make a significant difference over decades. Bear in mind that markets don't melt up so you can always get back in at a reasonable price.

Answer 5

I've considered the same question. I don't need to sell at the absolute top and buy at the absolute bottom - even if manage to capture 60% of the swing, that's pure profit right?

The problem is 401K's are not designed to do that.

First of all, most have 30 day cool down period - if you sell a fund, you can't buy back in it for 30 days.

You also generally have a limited choice of investment options within a 401k. Once you sell what do you put your money in? Cash is risky in case of inflation. You probably won't be able to pick individual stock and gold might not be an option.

That combined with the uncertainty of the timing just makes it too risky. Maybe if you put part of your money into a self-directed IRA, then maybe you'll have more options and the whole thing will be more feasible, but you still need to stay on the lookout for market changes and beating Wallstreet is very difficult.