Many investment and personal finance experts believe that it’s time in the market, not timing the market that will increase your investment success. Even researchers showed this to be true. Trying to time the market is futile. I am definitely on board with this philosophy when it comes to my own investments.
With that being said, I think that there are a few situations that you can further increase your chance of succeeding as an investor by timing the market. So, how do you define success? For starters, it’s not the percentage return on your investment that makes you a success. It’s the return that you make after taxes is what matters.
Let’s illustrate what I mean with a simple example. Investor A makes a reasonable annual return of 7% on his investment, but with a great tax minimization strategy, his tax bill only cost him about 1% of his 7% investment return. Hence, Investor A’s annual net after-tax return on his investment is 6%.
On the other hand, you have Investor B, who makes a great annual return of 10% but has no tax minimization strategy. As a result, his tax bill cost him a whopping 5% of his 10% investment return. Hence, Investor B’s annual after-tax return is 5%.
From the two examples, we can see that what you keep is more important than what you earn. To help you keep more of your money, I have a few strategies to help you time the market, increase your after-tax returns on your investment and keep more of your money in your pocket. Let’s see what they are.
Re-balance Your Portfolio
If you ask different experts, “How often should you re-balance your portfolio?” Depending on who you ask, some will recommend once a year, while others may recommend twice a year. If you ask me, “I’ll recommend re-balancing your portfolio based on the market condition and your investment performance.”
For my own portfolio, if a certain stock/sector is performing very well and the weighting is increasing over a certain percentage (let’s say 20%), I’d sell a portion of that stock/sector to lock in the gain. I will then reallocate that money to other sectors that are currently underweight.
By timing the market to re-balance your portfolio, it can help you lock in your gains, lower the volatility of your portfolio and reduce your investment risks.
Take Advantage Of People’s Panic
According to Warren Buffett, as an investor, you should “be fearful when others are greedy and be greedy when others are fearful.” I use this philosophy to take advantage of people’s emotion and psychology to time my options trades. When there are fear or euphoria in the stock markets the premium that people pay to buy options tend to go up. If you need a refresher on how options works, check out my options basics post.
To illustrate how I take advantage of people’s fear, let’s go back to April 18,2017 when Goldman Sachs reported their first quarter earnings. The quarterly highlights were: total revenue increased by 27% and earnings per common share increased by 92% year over year. On top of that, they increased their quarterly dividend from $0.65 to $0.75 per share per quarter. With these types of numbers, you’d expect the stock price to skyrocket, wouldn’t you?
Ironically, Goldman Sachs’ stock price dropped from $226 to $215 per share that day. This was due to analysts having higher expectations for their revenues and earnings. I did not see anything bad about these quarterly numbers. Seeing the panic, I made my move by selling two put options contracts. These contracts allowed the purchaser to right but not the obligation to sell me 200 shares of Goldman Sachs common stock at $185 per share anytime until January 19, 2018.
For the transaction, the purchaser paid $1,368 for the rights just because the quarterly numbers were below the lofty analysts’ expectations. Fast forward about eight months later, Goldman Sachs stock price is about $256 per share as of December 14, 2017. If the sky doesn’t fall within the next month, I don’t think the purchaser will want to sell their 200 shares to me for $185 each. Hence, I get to keep the $1,368 in premium.
Support People’s Euphoria
Another way to time the market is when there is an excessive or an abundance of optimism in the marketplace. A great example of this euphoria is the cryptocurrency mania. There hasn’t been a day that has gone by without me encountering headlines related to cryptocurrencies, namely Bitcoin. I wish that cryptocurrencies are easy to understand and straightforward to invest like stocks, but it’s not. So I will stay away regardless if there is a great opportunity to make money right now.
This is a little off topic, but if you haven’t read about the Tublip Bulb Mania during 1630 in Holland and the South Sea Company during 1711 in England, it’s a great financial history lesson. After you’ve read these two events, you’ll understand why I am staying away from cryptocurrencies (and you should too, there’s just too much risk and volatility).
Now back to how I took advantage of people’s optimism to help improve my investment returns. When I own a stock that had significantly increased in price and reaches the 52 weeks high or the all-time high, I start to write cover call options contracts for those stocks. When selling a cover call contract, I am providing the right, but not the obligation for the options purchaser to purchase the underlying stock that I own at a specific price within an agreed time frame. The purchaser pays me a premium for this right.
Normally, I will set the strike price at least 10% higher than the current price. During this time, I collect the premium from the purchaser upfront and also receive dividends from the company if they pay a dividend. If the purchaser exercise his/her right to purchase the underlying stock, I will make at least another 15% on top of my gains. If the options are left to expire, I get to keep the premium and it’ll be taxed preferentially as capital gain.
Tax Loss Harvesting
When investing in individual stocks, inevitably there will be winners and losers in my portfolio. Because I make trades throughout the year that often resulted in capital gains, I need to find ways to offset my gains so that I pay a minimal amount of income tax. The methods that most investors use to pay less capital gain tax is Tax Loss Harvesting.
Tax Loss Harvesting is selling the loser stocks in your investment portfolio to lock in the loss of those stocks and to offset the capital gains you have in the same year. Unless the investment I made was either horrible or a mistake, the stock that I sold to lock in the capital loss, I’ll use the same fund to buy a competitor stock in the same industry. This way, I get the capital loss benefit to offset my capital gain without impacting my investment portfolio.
A great example is when I sold my Potash stocks to lock in the losses and bought it’s competitor’s stock, Agrium. Fortuitously, Potash and Agrium decided to merge into one company. As a result, I was able to take advantage of this tax loss harvesting and still end up with the exact same portfolio weighting as before. Most people usually do tax loss harvesting at the end of the year. For me, I time my activities based on my gains and losses.
My Two Cents
In terms of investing in the stock market, I can honestly say that I had tried to time the market before and I was lucky to get it right less than half the time. As a result, my investments are now spending more time in the market rather trying to time the market. However, the market fluctuates on a daily basis and there are opportunities for you to time the market to increase your investment returns without jumping in and out of the market. I hope that the four strategies presented here can help you manage your investment better and keep more of your money in your pocket.
So readers, what strategies do you use to improve your investment returns, keep more of your money and pay less income tax? Do you believe in time in the market and not timing the market when it comes to your investments?