How can I enter the market today at such high valuations to meet 20 year long investment objectives?
I am a 34 year old long-term systematic investor planning for my children's education and my personal retirement. I deploy a monthly fixed sum on a diversified portfolio of ETFs of US stocks, Emerging stocks, bonds, European stocks, etc. I am also receiving a large liquidated sum of a real estate asset that I would like to invest in a long-term goal. What is the best way to invest currently, considering markets are at a significant high? In my earlier systematic plan, I am investing over a long period of time, on a weekly basis through a robo advisor, thus averaging my cost. However, with a second type of lump sum investment, what is the best way to approach this?
You are right to be worried at these valuations, both in the equity and bond markets. And there are well documented, large drawdowns/bear markets in equities approximately every 8 years going back to the early 1900s. Before that the data becomes spotty. Bond bear markets occur less often, but we are reversing from a long term bull market & dropping interest rate cycle so bonds have a much higher risk profile than they did just a year ago. So depending upon when you put the money to work depends on you results if you are a buy-and-hold investor.
I am going to give you a different perspective than the buy-and-hold pie chart perspective that many advisors adhere to. You should have a sell discipline for the positions in your portfolio at these levels. This is because it is more about the risks in the markets than your risk tolerance contrary to what you have been told. And people's risk tolerance changes over time. When the markets are going up, everyone wants in, but when the market goes down, everyone becomes risk adverse.
Now, if we were just coming out of a bear market my answer & strategy would be different, but you have to invest now and don't have the luxury of picking the markets or decade to invest. All this said, the markets can go up longer and farther than people think, but they will also fall farther as well.
Now you are fine dollar cost averaging small monthly increments directly into investments, but the large corpus should be protected. Otherwise you could lose years' worth of the "monthly increments" in the next bear market. At our shop we use mid-term technical indicators so that we give the markets room to "breathe" but will exit if selling begins to accelerate. As this happens more and more stop loss levels are triggered and selling begets selling. When this happens, correlations between most asset classes merge and decline in unison. So at the exact time you need diversification for non-correlation to protect you, it is not present.
The problem with waiting is that it could be quite a while before the markets experience a significant correction. And with these artificially low interest rates, there is no "safe haven" asset that pays even enough to even keep up with inflation while you wait. Therefore, you are guaranteeing a purchasing power loss on your idle money in the money market or CDs if kept there for a period of time.
For those who like the roboadvisor model using low cost ETFs, we actually employ our Robotection® approach using the same low cost ETFs & main asset classes. But each segment or "slice of pie" has a sell discipline so that if it breaks certain levels that portion defaults to cash (money market). So you may be fully invested, or have just one or two asset classes in cash, or even more if it begins to get really ugly. For more active investors, we employ a more active, tactical approach.
I am not trying to sell you, but rather just giving you a different perspective than the buy-and-hold mantra. There is some great literature to research about various technical indicators. You don't want to use too short term indicators where you are constantly trading all of the time, but rather midterm indicators so that you attempt to measure the overall trend, especially when using indexed or sector ETFs.
You will occasionally get "whipsawed" (in hindsight) getting out only to have the market reverse and resume higher. But when you do miss a big portion of the next major correction, it will be worth it. And you are only a couple of transactions away from getting back in. There are times when making is easy & everything lines up that I don't need to take excessive risks. Now is not one of those times. In this current environment, I would rather get stuck out wishing I was in, than in wishing I was out.
If you can keep a large portion of you principal from getting caught in the next bear market, then you can resume with your original or similar strategy until we get lofty valuations again. Therefore, I think your instincts are spot on and you have some more research to do.
Hope this stimulated your thought processes and best of luck, Dan Stewart CFA®
Given your extended time horizon, I think you are moving in the correct direction. Investing regularly on a systematic basis is akin to dollar-cost averaging. Dollar-cost averaging has its pros and cons. One pro is the sense of controllingyour cost positioning when you invest over long periods of time. At times such as these when valuations are stretched, not only will you get that advantage, but you may also gain better average pricing if you use the same approach with the lump sum you refer to.
Further details of your investments would help. With that said, however, I suggest you simplify your portfolio. At your age, there's little reason other than risk mediation by holding fixed income. A few exchange-traded funds holding broad range of U.S. and international is sufficient. A decade or more from now, you might begin adding well-selected fixed-income securities. For your children, a 529 plan would be appropriate, heavily invested in equities until they are in their early teens.
You have a valid concern in wishing to avoid a "flash crash" or wait to invest the lump sum until a significant decline. However, you can see that historically the market has continued to rise in spite of temporary dips. I would ask yourself if you would regret more a dip after investing or missed growth before investing. Weekly or monthly contributions are a great way to average cost as you mentioned. You could break up your lump sum and increase those contributions as a compromise.
If you are a systematic investor then you should already have been significantly reducing your exposure to stocks and increasing your exposure to investments with a fixed principal like bank accounts. Accelerate this process so you have as little as possible in the various ETFs you mentioned above, and much more in guaranteed accounts paying 1% or so.
After the U.S. stock market collapses, gradually increase your risk in various funds through frequent small purchases each time the market drops on any given day.
This strategy worked very well in 2000-2002 and again in 2007-2009. Those who had as little exposure as possible ended up far ahead of those who stubbornly remained heavily invested.
My suggestion is to ditch the bonds and european stocks for now. Take a look at trends and buying opportunities to maximize returns for the year. For instance, the tech sector has seen some volitility recently so it might be a great idea to buy stocks like Facebook, Amazon, Apple, Netflix, Google, and Alibaba. It also doesn't hurt to utilize leveraged ETFs to take advantage of single day gains. I hope this helps!