The Importance of Timing

In November of 2008, as world markets were crashing and major economies were falling into recession, Queen Elizabeth paid a visit to the London School of Economics. Normally non-confrontational in public, the Queen challenged her audience that day, asking, “Why did no one see this coming?”[1]

While the 2008/2009 recession was unusual in its severity, it was just like every other recession in one respect: as the Queen observed, no one saw it coming. In fact, it wasn’t until September of 2008, when it had already become fairly obvious, that economists began forecasting a recession.[2] While that failure may seem shocking, the reality is that economists have always had a poor track record forecasting recessions. According to a 2001 study conducted by International Monetary Fund economist Prakash Loungani, economists were successful in predicting just two of the sixty recessions that occurred around the world during the 1990’s.[3] Loungani’s conclusion: “The record of failure to predict recessions is virtually unblemished.”

Following the Queen’s 2008 meeting in London, a group of prominent economists attempted to provide a satisfactory answer to her question. In their reply, the economists wrote, “…your majesty, the failure to foresee the timing, extent and severity of the crisis…was principally a failure of the collective imagination of many bright people…”[4] Unfortunately, a failure of collective imagination is not the kind of problem that lends itself to an obvious solution, so it’s not surprising that, according to Loungani, economists’ track record since 2008 hasn’t been much better.[5] As the saying goes, it’s difficult to make predictions, especially about the future.

This inability to predict extends to the stock market as well. Studies going back to the 1960’s have shown that most people lack the ability to successfully “time the market” – that is, to profit by jumping in and out at just the right time.[6] However, there are many other aspects of personal finance in which you can and should consider using timing to your advantage.

Timing can be very important when establishing a trust for the benefit of your family. Because estate tax rules limit the total dollar amount that parents can give to their children (or anyone else) without triggering a tax, the most tax-efficient assets to transfer are those that appear to be trading at depressed prices. Why? Because depressed assets may have the strongest appreciation potential, and any appreciation that occurs after the transfer does not count toward the donor’s cap on gifts. To take a simple example, if a parent gives her child $100 in stock, and it later grows to be worth $150, the gift, from the perspective of the IRS, still only counts as $100. For that reason, it can be worthwhile to use timing to your advantage when making gifts. If possible, you would want to complete your gifts during periods when the value of your financial assets appears depressed. There is no need to employ sophisticated analysis to make this kind of assessment. If the market, or a particular stock, is trading near a 52-week low, or if the valuation in terms of its price/earnings ratio is near the low end of its historical range, then it may be an opportune time to make a gift. If, on the other hand, the market is at an all-time high, you might want to be more cautious, perhaps stretching your gift out over time or choosing an asset from your portfolio that happens to be trading at lower levels.

It also makes sense to consider timing when making charitable contributions. If you have charitable intent, then it is important to think in terms of a multi-year strategy, with the objective of minimizing your total income tax bill over that period while also meeting your charitable objectives. The key questions to ask are:

• Have you established the total amount that you would like to donate?
• Do you intend to make gifts out of your future income or do you already have the assets you would like to donate?
• Do you intend to donate cash or investment assets? Do you have stock in a private company?
• Is your income predictable or does it vary significantly from year to year?
• Does it matter when the recipient charities receive the funds?
• Are there other factors, such as special tax credits, which may impact your tax situation from one year to another?

Because many tax rules are calendar-dependent, the answers to all of these questions will be important as you formulate a plan for making charitable gifts. You should work with your advisors to map out a strategy and timetable that fits your particular situation and then be sure to revisit it each year as things evolve.

The stock market and the overall economy are virtually impossible for economists to forecast because they depend upon unpredictable factors that are outside their control. Your own personal financial situation, on the other hand, has far fewer unknowns. For that reason, it is possible, and may indeed be very rewarding, to make predictions and to time important financial decisions to your advantage.

 

[1] “How Gamblers Broke the Banks,” Financial Times, December 15, 2008, http://on.ft.com/1PONsSx, Retrieved February 2, 2016.

[2] “Fail Again? Fail Better? On the Inability to Forecast Recessions,” Prakash Loungani, presentation delivered at the Federal Forecasters Conference, September 24, 2015.

[3] “How accurate are private sector forecasts? Cross-country evidence from consensus forecasts of output growth,” Prakash Loungani, IMF Working Paper, April 2000.

[4] “Queen told how economists missed financial crisis,” The Telegraph, July 26, 2009. http://www.telegraph.co.uk/news/uknews/theroyalfamily/5912697/Queen-told-how-economists-missed-financial-crisis.html, Retrieved February 2, 2016.

[5] “Fail Again? Fail Better? On the Inability to Forecast Recessions,” page 8.

[6] See, for example: Jack L. Treynor and Kay K. Mazuy, “Can Mutual Funds Outguess the Market?” Harvard Business Review, July-August 1966, pp. 131-136.