Concerns about market downturns certainly come as no surprise. After all, steep corrections and crashes can be disconcerting for even the most steely and disciplined investors.
What has been surprising to me, however, is the number of inquiries I have received over the years raising concerns about the stock market being “too high” or “overvalued.” These concerns generally manifest themselves in some variation of questions like the following:
“Now that the market is so high, should I reduce (or eliminate) my allocation to equities?”
“With the market so high, should I really be investing this cash right now?”
These are logical, appropriate and entirely rational questions, and only a flinty-eyed Vulcan would think otherwise. Well, I’m no Vulcan, so I’m going to share not only logical, but also psychological, insights into whether or not it may make sense to invest hard-earned dollars when the markets are high.
I distinctly recall implementing a new portfolio just after the market breached 18,000, a new high at that time. I recognized that the market was at an all-time high, yet in the absence of a clear crystal ball (something that no one possesses), proceeding with the well-thought-out plan remained the prudent option. I was confident in this course of action because less than a third of this new portfolio had exposure to the asset class that the financial media and general population refer to as “the market.”
Did you notice how casually I equated “the market” with the Dow Jones Industrial Average in the preceding paragraph? One of the critical keys to investing when “the market” is at an all-time high is to ensure that your portfolio is not concentrated only in asset classes represented by benchmarks popular in the news. When someone brings me a concern about “the market” being high, I must ask, “Which market are you referring to? Domestic stocks? International stocks? Bonds? Value stocks? Growth stocks? Large-cap stocks? Small-cap stocks? Real estate? Liquid alternatives?” I’m sure you see where this is going.
Diversifying among various sources of risk serves as a hedge against placing too much wealth in only one risk basket. Thus, while a conventional portfolio heavily concentrated in large-cap U.S. stocks may rightfully cause concern when popular benchmarks such as the Dow or the S&P 500 are at all-time highs, it doesn’t necessarily mean that other asset classes or sources of risk are as richly valued.
Taking the plunge
A common fear of investing cash when the stock market has reached a new high is the possibility of a market crash shortly after deploying the funds. Although this is a rational and understandable fear, the evidence demonstrates that investors are best served by ignoring recent market performance. The timing around when to invest in the stock market should instead be governed by a holistic plan anchored in your goals and that takes into account a wide range of potential market outcomes. At the beginning of each trading day, the expected return for stocks is positive, regardless of what happened the day before. Thus, it’s always a “good” time to invest for the long-term. And if today isn’t a good day to invest, when would you know the “right” day to invest has arrived?
Exhibit 1 puts those fears in a broader context. It shows the average annualized compound returns of the S&P 500 from 1926–2019. After the index has hit all-time highs, the subsequent one-, three-, and five-year returns are positive, on average. After the S&P 500 has fallen more than 10%, the subsequent one-, three-, and five-year returns are also positive, on average. Both data sets show returns that outperform those of one-month Treasury bills. Overall, the data do not support that recent market performance should influence the timing of investing in stocks.
From this data we can conclude that trying to time an entry point for investing cash is futile.