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How to Frame Investing Near A Market High?

by | Mar 5, 2018

Over the past 5 years or so, some investors have shared a similar question. “With the stock market near all-time highs, should I be investing right now?” At first glance, it seems logical to be hesitant at the idea of investing near a market high. In fact, many arguments around trying to time the market usually do sound logical. However, in practice, people have been failing at timing the market for decades.

The reason? There has been no method proven to be successful at timing the market successfully over time. Some professional money managers will try and sell you that they can. Others will admit it can’t be done. But the truth is, claiming to be able to time the market is the same as claiming to be able to tell the future, yet I’m sure most would scoff at that claim. So why, then, do investors think that when it comes to the stock market, people actually can see the future?

With that said, because no one has a crystal ball, what are investors supposed to do when the market is near an all-time high? Here are some things to consider:

Not the First All-Time High

One thing is certain about the future; our next “all-time high” will not be the first of its kind.. And, each new all-time high is not always followed immediately by a correction. Many times, all-time highs are followed by, you guessed it, new all-time highs. The Dow Jones Industrial Average alone hit record highs in 2013, 2014, 2015, 2016, and 2017.1 In 2017, the Dow Jones hit four 1,000-point milestones for the first time ever. Had investors not invested during those years for fear that the market was already at an all-time high, they would have missed the gains that came in those years.

Good Years Outnumber the Bad Years

If you’re invested in stocks, you should have a long-term time horizon. The reason is that virtually anything can happen in a one-year period, but when you look over an extended period of time, stocks have a better chance to average out the bad years with the good years. And, the good years have come approximately 75% of the time, according to the CRSP 1-10 Index from 1926 – 2016.2

So, even if you hypothetically invested and experienced a decline in your first year in the market, by keeping your money invested long-term, you would allow your stocks to potentially rebound and still generate a positive return.

The most recent major decline of 2008 is a notable example of that. There was a major correction in 2008-2009, but we’ve seen a remarkable bull run since then. And, because of that, those that stayed in the market after 2008 have not only gotten back what they temporarily lost, but have earned significant gains on top of that.

Major Corrections Can Happen Any Time

Investing at any time is not about predicting the short-term, but it’s about choosing the right asset allocation mix at the outset. The market doesn’t have to be at all-time highs to have a major correction. Therefore, investors must carefully evaluate what level of volatility they can accept at any given time, because a major correction may occur at any point in time.

Using a Bucketing Approach

In the investment industry, we often look at a portfolio’s asset allocation as a percentage of equities (stocks) vs. fixed income (bonds). For example, a 60/40 portfolio is one with 60% stocks and 40% bonds. The goal of using stocks and bonds is to add diversification. However, the purpose for this differentiated approach should go deeper than just that.

A helpful way to further dissect a portfolio’s asset allocation is to think of it in terms of different buckets; short-term, mid-term, and long-term. A short-term bucket represents your potential short-term needs (0-2 years). The investments that make up that bucket should therefore have a short-term time timeframe to match your time horizon. Good examples of this would be cash or short-term bonds.

Next, you have a mid-term bucket, which may represent a timeframe of 3-10 years. Therefore, the investments used in this bucket should have a time horizon that matches that mid-term time frame. In this case, that may mean using intermediate bonds and potentially some more established stocks.

Lastly, you come to the long-term bucket. This bucket should be for money you will not need for 10+ years. Here, you can explore investments that have a higher long-term upside, even though that may mean more short-term volatility. You can do this because as long as you have sufficient assets in your short-term and mid-term buckets to cover any potential needs, you won’t need to worry about having to sell anything in your long-term bucket.

And, if you look at performance of mutual funds or stocks over a period of 10 years, you’ll see that in many cases, the returns are not only positive, but they can be substantially higher than a cash alternative. So, if you know you won’t need the money in that bucket for 10+ years, why panic if there is a temporary decline?

The Bottom Line

Nobody knows when the next major market correction will occur. But, with proper portfolio construction and good investor behavior, you should be able to withstand a market correction and still come out ahead. Too many people think “If I could just avoid the next major correction, it will put me well-ahead of where I would have been.” The problem is with that approach is that you give up too much upside while you’re waiting for the crash. Imagine how much gain was lost by those that have been on the sidelines since 2013!

If you cannot remove the emotion from investing, and you cannot commit to a long-term time horizon on your equity allocation, then you shouldn’t be investing in equities. Why? There are few scenarios worse than panic-selling after a major market correction and never recouping your losses. In that case, you would have been better off burying your money in the backyard.

1 Data from The Balance. See https://www.thebalance.com/dow-jones-closing-history-top-highs-and-lows-since-1929-3306174, which cited “Business Cycle Expansions, and Contractions,” NBER. “Recession History,” The Balance.com.)

2 In US dollars. CRSP data provided by the Center for Research in Security Prices, University of Chicago. The CRSP 110 Index measures the performance of the total US stock market, which it defines as the aggregate capitalization of all securities listed on the NYSE, AMEX, and NASDAQ exchanges. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results.

 

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