Should You Invest When the Market is High?
Some investors today are worried. They’re asking, “is now the right time to get into the markets?” Their primary concern is putting money to work at the top of the market, only to see their precious savings decline in a selloff. And they have good reason to be concerned. Volatility in certain parts of the financial markets remains elevated while asset prices continue to drive higher and, by many measures, are disconnected from fundamentals. So, what should an investor do to avoid losses associated with investing at the wrong time in such an environment?
Maybe you’re sitting on cash and asking whether you should put your money to work now or wait until conditions settle down a bit? Truth be told, not investing at market highs is a fallacy because there is generally no wrong time to invest in the markets. More specifically, the right time to be putting money to work in the markets is when your investment strategy balances your income needs with capital appreciation and other savings goals.
In fact, staying out of the markets at an inopportune time might cost you in terms of growth over the long-term for the benefit of avoiding a loss in the short-term. To be sure, the key to navigating financial markets during periods of uncertainty is to avoid market timing altogether. When it comes down to it, investing isn’t so much about divining market direction. It is about adhering to a strategy that enables you to achieve and maintain financial independence regardless of where you are in the market cycle.
Remaining Disciplined when Markets Are Uncertain
Our last article discussed methods for staying sane and avoiding unnecessary risk-taking when it appears the market is going crazy. There’s little doubt that those principles remain relevant today. Nevertheless, some individuals are sitting on the sidelines, worried about losing money in today’s frothy markets and unsure what to do next.
Before we discuss why and how you could invest your savings, let’s address a critical anxiety-provoking issue facing many disciplined investors: signs of a market top. By various measures, price action in certain parts of the markets makes little sense today. Some traditional investing theory suggests that an asset’s value depends on its future earnings, cash flows, or potential store of value discounted at today’s price. Therefore, the value of an asset can be explained, at least in part, by a rational understanding of the underlying factors, or fundamentals, underpinning the directional move in an asset’s price.
As we pointed out last month, however, markets are also be fueled by periods of irrational social dynamics rather than logical fundamental analysis. One of the key concepts we previously highlighted to this point was the Greater Fool Theory. And this theory suggests that asset prices will rise solely because some individuals believe that others will be around to bid prices higher in the future. And it’s this very phenomenon that has underpinned notable historical asset price bubbles that seem to pop up once or twice a decade. Presently, the gyrations in “meme” and high-flying tech stocks and bitcoin underscore the disconnect between rational decision making and price action.
So how long will the current craziness last? The truth is that no one can divine where the market is heading in the near-term. Still, certain developments would suggest that higher price momentum for questionable assets is coming under pressure. This view has become evident in heightened volatility among penny stocks and cryptocurrencies and rising yields, and other dislocations in the bond markets themselves. Under current conditions, there’s little doubt that having money in the market, notably, if you’re dependent on that money to cover lifestyle needs in the near-term, is disconcerting at the moment.
Timing the market Isn’t an Efficient Investment Strategy
Certainly, there’s a sense of comfort that comes from sitting on cash in anticipation of what seems to be an imminent end to an otherwise irrational period in the financial markets. Trying to time the markets, or waiting on the sidelines until the craziness ends, may not, however, be in your best interest. Why? Well, how certain can you be about the timing of a highly anticipated market pullback, and what’s the cost of getting the timing wrong? Well, history has shown that missing some of the best days in the markets can cost you significantly, depending on your savings horizon.
For example, over the past 50 years, investors missing out on the ten best days in the markets might have had a portfolio value half the size of those who remained fully invested. On the flip side, you could argue that staying out of the markets during a time of uncertainty could help you avoid losses during a sharp market pullback. While this sentiment may be true to a certain extent, again, you’ll need to be able to answer a few key questions to make this approach work: First, when will the selloff begin? Second, how long will the next selloff last? And finally, when should you get back into the market? Will you wait one day, a week, or month for an all-clear sign to reinvest your savings?
The challenge here is that the longer you wait to answer these questions, the more it may cost you as you miss out on periods of critical market rallies that are essential to fueling compounded growth of your savings over the long-term. To understand this concept with a little more clarity, let’s consider hypothetical investment performance following sharp market pullbacks.
Now, if we gather data for the ten worst single-day selloffs in the S&P 500 index over the past 50 years and evaluate performance a year later, what does history tell us? Well, the data shows us that during these historic down days in the S&P 500, the index fell an average of 8.8% in a single day. So how did it perform a year later? The same data set showed that the sharp selloff was followed by an average gain of 24% in the following twelve months. The takeaway here is that avoiding the markets altogether could cost you in terms of lost appreciation and compounded growth if you happen to make decisions based solely on market timing.
A Prudent Approach to Investing in Uncertainty: Manage Risk, Stay Disciplined
So, is now the right time to get into the markets? Should you wait until the markets settle before putting your money to work? Well, rather than concerning yourself with the next move, higher or lower in the market, now may be the time to evaluate how you’re positioning your investments in the current environment. More importantly, it would help if you considered whether your portfolio is appropriately balanced to meet your short-term living needs and long-term capital appreciation goals.
While the answer to this question will vary from one individual to the next, let’s consider how you might be able to approach the market from the perspective of an investor with varying capital distribution and appreciation needs.
The Already Retired Investor
Suppose you’re already retired and dependent on your investment savings for income. In this case, your primary concern might be to find an optimal balance between income needs to weather a market selloff in the short-term and continued investment growth to avoid the harmful effects of inflation over the long-run. So how much money should you set aside in your portfolio? While the amount of cash you should have on hand will vary depending on your unique circumstances, one rule of thumb if you’re already retired is to have enough cash on hand to cover two to three years’ worth of lifestyle needs.
The benefit of this approach is twofold. First, having a few years of cash on hand will enable you to preserve your wealth for the long-term without worrying about the periodic ups and downs in the markets. To be sure, rather than selling all of your investments during a period of uncertainty, remaining fully invested in the markets while holding a higher allocation to cash might enable you to address lifestyle needs without being forced to sell investments at an inopportune time.
Compared to a cash-only portfolio, the second benefit is that allowing a portion of your savings to maintain market exposure might provide continued investment appreciation while avoiding a shortfall should you live longer than expected. Price inflation or a rising cost of living can be detrimental to your retirement plans, especially if you outlive your savings. Even so, history has shown that the longer you invest your savings and allow the power of compounding to work, the less likely you are to experience a cost-of-living shortfall should you live longer than you had planned.
Soon to be Retired Investor
Now, what if you’re not yet retired but plan to leave your job in the next few years? Well, one challenge faced by some soon-to-be retirees is the need to reposition their portfolios from a high concentration in stocks or riskier assets to a more diversified, preservation-oriented allocation. During seasons of heightened market uncertainty, you might be tempted to go to an all-cash portfolio when a market pullback seems imminent, and your retirement is just a few years away.
Nevertheless, when it comes to preparing your savings to address long-term retirement needs, going to cash may not be the most optimal approach. In fact, one of the most effective strategies you can consider is to evaluate your income needs during your first few years of retirement, set aside that amount of money, and stick to a disciplined rebalancing plan.
Like individuals who are already retired, having enough cash to cover 2-3 years of retirement expenses might help you avoid selling investments at an inopportune time. More importantly, having the optimal amount of cash on hand might ease your anxiety during periods of market uncertainty, especially as you transition into your post-employment years.
Next, ensure that your investment portfolio is diversified across several uncorrelated asset classes as a means to reduce the time it takes to come back from a market selloff. To be sure, history has shown that, even when you’re invested at a market top, a diversified portfolio might recover from losses months and even years sooner than a highly concentrated portfolio as illustrated in the post-Global Financial Crisis period.
Not Retiring Anytime Soon Investor
Finally, what should you do if you don’t plan to retire anytime soon but are still concerned about investing near a market top? Well, if your plan for retirement is more than five years away, then one of the most important things you can do today is to ensure that you remain invested for the long-term and stay committed to a disciplined dollar-cost-averaging strategy.
It’s vital to recall that riding through periods of euphoria and despair, fear and greed are the cost of admittance to participating in financial markets. If you have a long-term investment horizon, your primary goal should be to allow the power of compounding to make your money work for you, rather than spending your time trying to divine the next move higher or lower in the markets.
To be sure, our earlier example of missing the ten best days in the markets is notably relevant to individuals with a long-term savings horizon. Therefore, rather than trying to figure out whether you should be in or out of the market, take the time to evaluate whether your strategy matches your risk tolerance and investment objective and commit to making the power of compounding work for you.
Should You Invest When the Market is High?
So, with some indices having hit all-time highs, is now the right time to get into the markets? Well, the idea of not investing when indices are near all-time highs suggests a prime time to put money to work. And the fallacy here is that there is no right or wrong time to be invested in the financial markets.
In fact, staying out of the markets at an inopportune time might cost you in terms of growth over the long-term for the benefit of avoiding a loss in the short-term. To be sure, the key to navigating financial markets during periods of uncertainty is to avoid market timing altogether.
When it comes down to it, investing isn’t so much about divining market direction. It is about adhering to a strategy that enables you to achieve and maintain financial independence regardless of where you are in the market cycle.
Read More Recent Posts
- From Six Figures and Broke to Financial Independence Master
- Should You Invest When the Market is High?
- How to Stay Sane when the Markets are Going Crazy
- Why Your Investments Might Thrive in 2021
- Are Vaccine Hopes a Shot in the Arm for the Markets?
- Look for Investment Opportunities in a Biden Win
- Why is Tax Efficiency Crucial to Retirement Savings and Income?
- Take these 5 Back-to-the-Basics Steps when Markets Move Against You
- These Two Techniques May Help You Avoid Gambling with Your Financial Future
- Has the US Dollar Lost its Dominant Reserve Currency Status?