Should I wait for the market to go down before choosing to invest?
I have cash that has been sitting in a savings account earning nearly 0% interest, but the market is at an all-time high. Should I wait for the inevitable downturn to invest?
Your question illustrates the difference between two forms of investing, dollar-cost averaging (DCA) and lump-sum investing (LSI). As outlined in a Vanguard white paper, “On average a LSI approach has outperformed a DCA approach approximately two-thirds of the time, even if results are adjusted for higher volatility of a stock/bond portfolio versus cash investments.” The reason for this is that the longer dollars are invested in the market, the longer they have to compound.
If you are confident in your portfolio allocation, understand your investment time horizon and are seeking the potential for maximum returns then you should put your dollars to work as soon as possible. If you are more concerned with loss avoidance and avoiding feelings of regret, then a DCA approach may be more appropriate. If you choose DCA however, be aware that you are likely reducing your potential future returns for short term piece of mind, which actually is likely not that big a deal.
Also, it is impossible to consistently and perfectly time the market and trying to do so can have severe consequences. The annualized total return of the S&P 500 Index from January 1996 to December 2015 was 8.2%. If you exclude the 10 best performing days, during the entire 20-year period, the annualized return drops to 4.5%. And if you missed the top 40 days, again during a 20-year period, the annualized total return drops to -2.0%! The moral of the story is to determine your risk profile, allocate your investments, and get started.
Most of your question depends on the time frame for usage for these funds and how the funds are to be invested. For reference sake, I’ll assume they will be in a well-diversified portfolio that is commensurate with your risk tolerance. The difficulties of timing the market are pretty well documented at this point. It’s never going to be about getting the next uptick or downturn right, but about having to get it right multiple times over the course of many years.
This isn’t the longest bull market we have ever seen, nor is it the shortest. The usual definition of a bear market is when the stock’s decline by 20% from their peaks over a 2 month period. From the 1990’s till today, the S&P 500 has gone from a long bull market to a momentary bear, back to a 5-year bull, leading up to the most recent bear market of 08, and finally arriving at our current 8-year bull market.
That’s 5 changes in total, spanning the course of over 26 years. If you’re in it for the long term, you have to accept the historical fact that markets fluctuate. An accurate forecast isn’t always necessary for a successful investment experience. Discipline is often a far better ally to long term investors.
Timing the market can be a tricky thing. It requires that you make two perfect decisions. The first decision involves timing the buy just when the market pulls back and hits a “low.” The second is timing the right moment to sell when markets reach a “high.” This is very difficult, if not impossible to do consistently.
This is why many financial planners and investment advisors suggest a disciplined long term investment plan rather than trying to time the market. If you want to be a trader, that’s fine. I'm not suggesting that they are bad or doing it wrong. But trading is different than investing. This is especially the case if you are investing for the long term.
The fact that stocks are at all-time highs doesn’t mean a downturn is right around the corner. Regardless of the current level of the stock market, one should always assume that a downturn is possible.
Let your risk tolerance, investment objective, and time horizon be your guide. If you need these funds within 12 to 24 months, the stock market isn’t the place to be. But if you have a longer term horizon, I would caution against trying to time it.
I recently wrote an article called Dow 20,000 – What Does This Mean For Your Investments? I think it will help provide a little perspective about the recent highs in the market. I hope you find it helpful.
Please note that this should not be considered investment advice and is only educational in nature. Be sure to consult your own investment, tax, or legal professional for help with your specific situation.
Best of luck!
David N. Waldrop, CFP®
You’re describing market timing. We’ve all heard the common refrain of buying low and selling high. It’s easy, right? Sadly, like most conventional wisdom, that strategy overlooks important nuance. To win the timing game, investors need to guess both the right time to get in and the right time to get out. But here’s the catch, markets are fickle and ultimately unpredictable. Every data point on the planet may suggest a stock will soon fall, but an irrational market may decide otherwise. Worse, the entire market could move in the opposite direction of sentiment. Remember when people said the market would nosedive if the U.S. elected Trump?
To your point, historical averages suggest we are “due” for a recession. However, the market may very well continue upward. Meanwhile, inflation could continue to erode the purchasing power of the cash you leave in the bank. Ask yourself, how much does the market need to drop before you jump in? Is it 5 percent, 10 percent, 20 percent, more? It’s impossible to determine the exact bottom of the market.
At near-record market highs, someone that can’t emotionally withstand a sudden drop in portfolio value may consider a dollar cost averaging approach to entering the market. The downside to this approach is the opportunity cost of not putting all of your dollars to work. But strategy must depend on risk tolerance, liquidity needs, time horizon, etc. Regardless of how and when investors enter the market, we suggest people build diversified portfolios and maintain a long-term mindset. (For more, see: “Coaching Clients Through Financial Planning: How Advisors Add Value By Managing Behavior”)
Being at an all time high is by itself a meaningless parameter. After all, you want the market to continue to make all time highs! But yes, the market is getting pricey by historic valuation methods. The problem is, the market could still go much higher before the next big correction comes. Using the P/E ratio, which is a typical valuation method, the market could rise another 25% before correcting with a 50% drop.
Timing is always THE issue in investing. You could pick a mutual fund, divide your savings by 5, and invest 1/5 of the balance each year for the next 5 years. If a correction comes sooner, invest the balance. If not, you'll have an average price based on the next 5 years.