Ask Colin

If this is the top of a long bull run (end September 2005), then might I have to wait a couple of years for the right moment to be entering the market?

Note: This answr refers to my book The Aggressive Investor It is now available as Building Wealth in the Stcok Market.

I have no idea whether the end of September 2005 is the top of the bull market. To know that involves being able to predict the future and I avoid doing that for two reasons. Firstly, it is an exercise in futility, because nobody has ever found a way to do it with any consistency and mostly forecasters get it totally wrong. Secondly, once we make a forecast, especially if we do it in public, our ego gets involved and we lose our objectivity. We start to protect our forecast and selectively see only information that supports it.

My approach is totally different. I start with the view that anything can happen. I then assess the level of risk in the market and adopt a strategy to deal with it as best I can. This is all explained in detail in my book The Aggressive Investor.

Now that is out of the way, your real question should be, not whether it is the top of the market, but what you should do. I am not allowed by law to advise you in any way, because I choose not to hold a license to give advice. Instead I am focussed on education. All I can do is what I think is more valuable than specific advice and that is to make you aware of some things to think about and on which you should seek professional advice as to whether they may be appropriate for you.

Try not to look at the market too short term unless you are intending to be a short term trader. Your question suggests that you are not, but that you are an investor looking to ride the big trends. This year we have seen two corrections in a bull market. In April-May the market fell sharply, but has since gone on to much higher levels. The key thing is that the correction only undid a fraction of the gains since the bull market began in March 2003. We are now going through another correction. It may turn out to be the start of a bear market, though there is no conclusive technical evidence of that. It may therefore be appropriate to await clear signs that the falls are finished. If you never get such signs, then you are kept out of a bear market. However, if you do get such signs, then you can look for opportunities.

The opportunities are not found on the chart of the index. The chart of the index should drive only your global risk appraisal, never the actual buying and selling decisions, which must be made on the basis of individual stock charts. There are many ways to invest. Mine is to buy stocks that present a margin of safety in fundamental terms and which are breaking upwards out of an accumulation (value model) or consolidation (growth model) zone on the chart and therefore likely to trend upwards or which are already in an established uptrend. This is all described in detail in my book The Aggressive Investor.

Another way to deal with the big cycles in the market is called dollar cost averaging. This is not my method, but the following is an outline. I think it is an extremely sound way for someone to enter the market for the first time when they have no great experience. The method is based on the idea that it is difficult to time the market. It is therefore dangerous to put all your money into the market at one time. You just might pick the top for several or even many years. Instead, you put some of your money into the market each year for, say, five years. The aim is to spread it over the cycle. Some will be bought on the way down and some on the way up. You take 20% of your money and invest it in each of the five years. You always invest the same dollar amount. If the market is high, you will buy smaller numbers of shares. If the market is low you will be buying larger numbers of shares. The idea is that the average cost may be closer to the average for the cycle, rather than the top and also the bottom, both of which are equally difficult to identify except in hindsight. You can select some stocks and buy more of them each year, which is the ideal. However, if you do not have a lot of money to invest, you might be buying very small parcels, which will mean high transaction costs (brokerage). Therefore, you could also buy different stocks each year, so long as you understand that some will turn out to be better buys than others, but the overall portfolio cost will be average for the cycle. Avoid buying popular stocks that are highly priced at any time. Study the value investing approach and use that. Don’t forget that dividends are a third of the total average return from stocks.