Now that the DJIA has reached 20,000, is it still a good idea to invest in the market?
I'm 34 years old and will soon be receiving my bonus. I would like to invest in the market, preferably in an asset with a high potential for growth. However, I am a little pessimistic due to the fact that the market has rallied since 2009. Is there potential for capital appreciation, despite the record setting highs of today's market?
Great question. The 20,000 mark on the Dow is of no great significance despite occasional comments from folks who maintain that there's something magical about it. Far more important is the level of valuation, which is the relationship between the level of the Dow and its underlying earnings. The valuation is also known as the price-earnings multiple.
On average over time, normal valuations for the key indexes such as the Dow range from the mid to upper teens. Valuations tend to be higher when prevailing interest rates are low (as they are now) and when the pace of corporate earnings is accelerating.
At the moment, the valuation of the Dow is about 18 times estimated earnings for the current year, which is a bit rich, but not excessively so. As long as rates stay reasonably low and corporate earnings accelerate, the current valuation seems sustainable.
Your concern is about the potential for growth. Given your time horizon, which is probably five decades long, I think your focus needs to be long term. With a time horizon of 20 years or more, there's every reason to concentrate your investments in equities, which have always outperformed other asset classes over periods of 20 years or more. Still, you will need to be aware that equities are more volatile than other asset classes and pullbacks of 10% or so during most years are to be expected. Even with those pullbacks, the full-year results are usually gains.
So the potential for growth is available. You would be well advised to stick to equities, evenly divided between domestic and international issues. Vanguard has low-cost total market index funds for both that you should consider. Good luck!
That's a great question, and I do believe the market is not cheap. That said, the DOW 20,000 is just a psychological number. I wouldn't get too wrapped up with that or the media hype, but rather focus on the strongest sectors and stocks. Investors must put their money somewhere to grow and with interest rates still very near historical lows, it does make stocks more attractive relative to bonds.
If you are concerned, there are some mid and longer term technical indicators you can research so you have a sell discipline to protect against major pullbacks or bear markets. I am not talking about day trading, swing trading, or the like, but further out defensive strategies. You will give back some of the initial decline, but it can protect you against some portion of the bigger declines. But then you have to determine how to get back into the market, again using technical indicators.
At our shop, we employ both a technical and fundamental analysis. We always want companies with strong revenue and earnings growth, or at the very least are mature companies with strong cash flow because I will make mistakes or the market simply changes character, but the best stocks will hold up the best. 5% of all stocks go up during an uptrend, and likewise, 75% of all stocks go down during a correction.
Another strategy is employing stop losses below your positions (if stocks or ETFs) so that the ones working out can continue higher, but the ones that don't are culled fairly quickly so you don't incur big losses on any one position. If you learn to keep losses to single digits (-5% to -8% depending upon the volatility of the stock), you may have more success. Recouping from big losses is tough because compounding works both ways.
If you watch interviews of all of the best investors or traders whether in stocks, commodity futures, currencies, whatever, they all have a common thread - they kept most of their losses small (mid-single digits).
What I am telling you is somewhat controversial to many passive advisors who tell you that you can never time the market and should be fully invested at all times. I disagree with this approach and believe that cash is an asset class and a way to dial up or down portfolio risks (volatility).
Either way you chose, you do have time on your side which will bail you out of mistakes that you will make along the way. I would not let fear keep you out of the market.
Lastly and on a side note, if the new administration does get the economy moving, we may have higher yet to go. Perception is often as or more important than the reality. It can create its own reality.
Best of Luck, Dan Stewart CFA®
Turn off the news. Stocks always reach new highs, and that's simply the sign of increasing profits. You need to expect this to happen in a normal market, not worry about it when it happens.
Also, you're 34 years old. You don't need to be watching the DJIA. These are a few large US stocks. You need much more investments in terms of mid, small, value, international, emerging, etc., to balance your risk and increase returns. The DJIA is a tomato. You need to invest in a salad.
If you invested in large US stocks, you've seen a decade of 0% returns. If you diversified, I can show similar indexes of stocks that doubled during the same time period.
What's the difference? One is a tomato. One is a salad. Both are 100% stocks. And, as a 34 year old, one is entirely inappropriate. And, I would also say, so is the idea that you would base your 20-30-40 year money on a current 'high.'
I assure you the money that you invest for decades down the road will be far higher. And, you shouldn't worry about each 'high.' You should worry about what mix you have that may give you the best chance for the most growth. Over decades, that won't be the DJIA.
Many people may be pessimistic and that may be a perfectly normal feeling. Indeed, the market could come lower, or not. We cannot predict the future beforehand and history has shown that markets grow and that equities have achieved decent real returns, meaning excess return over inflation.
If you have a 25-year time horizon, I would be less concerned with the level of the DJIA today and expect that in 25 years, that it will be substantially higher. At a modest rate of return of 4 percent, you would see the DJIA in excess of 45,000.
I would focus on building a diversified portfolio with exposure to the main asset classes, based on your needs and your perceived ability to withstand whatever volatility comes your way.
If you are concerned about putting your money into the market all at once, secure in the knowledge that within days of your final purchase, that the market will retreat 20 percent, then you may want to consider putting your money in on a monthly basis. While dollar cost averaging does not guarantee a superior performance, you may be making purchases at both a lower or higher price.
Be diversified in a portfolio suitable for your risk and sleep well at night.
Let your investment objective, risk tolerance, and time horizon be your guide. Identify what you are investing for. Understand how far into the future it will be before you need the funds. Be aware as to how comfortable (or uncomfortable) you would be weathering short term drops in the market.
No matter what level the stock indices reach, whether they be record highs or record lows, there will always be people with opposing views. Some will say the market is about to crash while others will say there is room to grow. A long term investment approach requires the ability to tune out the noise. In any market environment, there will always be risks and if you try, you could probably come up with a thousand reasons why now might be a bad time to invest. But, the same could be said when the Dow was at 17K, 13K, 10K, and 7K.
This should not be construed as investment advice and should only be considered educational.
Best of luck!
David N. Waldrop, CFP