There are good times to invest in growth funds, and there are bad times to invest in growth funds. But how does one take advantage of the best and avoid the worst?
We all know there is no bell that rings, signalling when to buy or sell the hottest market segment or investment type. The only clear vision we have, with regard to market timing, is in hindsight. But as Mark Twain once profoundly proclaimed, “History does not repeat itself but it does rhyme.”
Therefore, the prudent investor will look for the rhyme.
Finding the Rhyme of Growth Stock Market Timing
With the advantage of hindsight, perhaps the best historical lesson about market timing and growth stocks is the technology boom of the late 1990s and the subsequent bust of the early 2000s. The best time, in terms of calendar years, to invest in growth funds during that period was 1998-99 and the worst time was 2001-02.
Consider the performance of the tech boom darling of growth mutual funds, Janus Mercury, which was so stigmatized following the bust that it later changed its name to Janus Enterprise (JAMRX):
- From the beginning of 1998 through the end of 1999, JAMRX had a staggering gain of 162.8%, compared to the S&P 500 Index gain of 50.4%.
- From the beginning of 2001 through the end of 2002, JAMRX fell 46.8% but the S&P 500 declined 31.8%.
- In 2003, after the bust was over, JAMRX jumped back up 40% and the S&P 500 had a smaller leap of 33.1%.
Again, there is no magical bell that rings in announcement of a significant and sustained rise or fall in stock prices. But what does this data tell us about the timing of buying and selling growth stock funds?
Let’s take a look at a more recent rise and fall of growth funds — 2007 and 2008, respectively. We will then take a look at what happened in the recovery of 2009, and we will have more of a complete picture to view.
This time we’ll compare the S&P 500 Index to the best-performing large growth mutual fund in 2007, American Century All Cap Growth (TWGTX):
- In 2007, TWGTX jumped 46%, whereas the S&P 500 Index gained only 5.5%.
- In 2008, TWGTX fell 46.2% and the S&P 500 declined just 37%.
- In the recovery of 2009, TWGTX jumped 34.6% and the S&P 500 increased a smaller 26.5%.
How to Get the Most Out of Growth Stock Funds
Based upon our observations, the best time to hold growth funds is in the latter stage of a bull market. This is a period where valuations for stocks are considered to be expensive by historical standards but prices continue to climb higher.
The worst time to hold growth stocks is during a bear market. Therefore, growth stocks are simply an extreme version of the stock market as a whole — at the high points, growth does best; at the lowest points, growth does worst.
Returning to the theme of the difficulty in precise market timing, recall that growth stocks also tend to bounce higher off of market lows immediately following a bear market (see the third bullet point in each section above) in comparison to the S&P 500.
Therefore, for the patient and prudent investor, a good strategy for taking advantage of the extreme highs and lows is to begin dollar-cost averaging into growth funds when the major market indices have declined by at least 20%. You can then continue buying shares until the bear market has ended, which is signified by an increase of 20% in stock prices.
In different words, it is best (and easier) to buy on the lows of a bear market, and take advantage of a subsequent bounce in the recovery, than to try and guess when to jump in before the highs of a bull market, and risk getting hit by the inevitable and steep decline.
As of this writing, Kent Thune did not hold a position in any of the aforementioned securities. Under no circumstances does this information represent a recommendation to buy or sell securities.