As many investors discover, mapping out an investment plan is the easy part. Sticking with that plan is what separates investors from speculators.
Are you an investor or a speculator?
Many investors use a consistent, long-term strategy to build a more secure financial future through steady purchases of well-diversified investments.
Speculators and market timers are usually less concerned about consistency. They may switch investment philosophies on an emotional whim, sometimes treating their investments more like play money than the serious money needed for their financial future.
Most people would probably say they are investors, but the question is not so easily answered. During a bull market, it can be relatively easy to be a long-term investor. However, when the stock market starts gyrating, investors' mettle can be tested—revealing many closet speculators.
The risks of market timing
Market timers follow a fairly predictable cycle. When prices seem low relative to historical norms, they buy. When an investment's value seems to peak, they sell. This cycle is repeated with the next "hot tip."
In theory, market timing seems fairly rational, but in practice it rarely works. Even the most sophisticated investors, with years of experience and the best analytical tools, cannot predict the whims of the financial markets. What's more, market timers are often misled by emotional factors such as greed or fear. Many end up buying at the tail end of a market rally or selling in a panic at a loss.
The difficulty of timing the markets is complicated by the fact that most market rallies occur in brief spurts. Market timers waiting for the right opportunity to buy or sell risk being out of the market during these sudden market changes.
To benefit from market timing, you must accurately predict the future, not once, but twice. First you must correctly determine when to sell. Second, you must accurately determine when to get back in. Because falling markets can rise steeply within days, your timing must be nearly perfect.
Making decisions like an investor
To avoid falling into the speculator's trap, focus on the term "individual" before making any investment decision. Your individual long-term goals and your individual financial circumstances — not the daily gyrations of the stock market—should govern your decision.
By focusing on your individual needs and sticking to your investment plan, you could actually benefit from the stock market's gyrations. For example, a good long-term investment strategy generally includes investing a set amount at regular intervals. If you maintain this schedule during a market dip, you may end up purchasing some strong stocks at discount prices.
Of course, changing your investments during a gyrating market is not always speculating. It can be an astute, tactical decision if the reasons for your changes are consistent with your individual long-term goals.
Examining your goals
Instead of market timing, try lifestyle timing. Look at your own investment portfolio and compare it to your long- and short-term goals. Do you need to withdraw money within the next year or so to begin financing your retirement or to make some other lifestyle change? If so, you might want to rebalance your portfolio to a more conservative mix of assets.
What about your long-term goals? Short-term market gyrations will probably not significantly affect your long-term plans, and it may be wise to stick with your current strategy.