*This article has been updated as of February 2018.*
The stock market is up on both an absolute basis and from an inflation-adjusted valuation perspective. Should you be worried about investing your money now that the stock market is so high?
The short answer is: no.
If you look at it from a pure math perspective, the stock market will likely be higher ten years from now and certainly twenty years from now. So even if stocks get crushed in any short term period, it doesn’t matter if you have a long term perspective. It doesn’t make sense to judge your portfolio on a short term basis if you have a long term perspective.
But the issue is this: we’re all human. We have emotions. We feel pain. We actually feel more pain from a loss than from an equal-sized gain.
When you ask yourself if you should invest when the market is hitting all-time highs, you have to look at a couple other variables to get a more nuanced look at your specific situation.
You should ask yourself if you can handle a 50% decline in your portfolio? Think you can? You may not be able to even if you think you can.
You should be asking yourself about your time frame for holding stocks. If it’s less than a couple years and you take a big loss, you may not be able to recover your money.
You also need to look at the opportunity cost of your money. What else can you do with your money that would generate a return, potentially with less risk?
If you have a lump sum amount that you want to put to work, you should look into a few different strategies that align with your investing objectives.
1) Dollar-cost Averaging – Investing doesn’t have to be a binary decision. You don’t have to invest all of your money at once. You can slowly work into positions: get comfortable with investing, learn as you go, sleep better at night.
2) Hedging – Hedging isn’t just for the Wall Street suits; it’s for every average Joe investor out there. Farmers have been doing this for years. They’ll sell their crop at a price at a certain date in the future before the crop is even in the ground. You can start by reviewing certain options strategies that are low risk like covered call option writing.
3) Cash is King – There are certain times that simply holding cash is a better option. Cash gives you optionality. You’ll have the option to invest in the future – a future which may see lower asset prices which would be great for you. Sometimes waiting is okay. I’d rather make a conscious decision to hold cash than to feel like missing out on something and rush into a bad investment. Some investments are difficult and costly to exit.
Investing When The Market’s High
It can be hard to invest when you think prices are currently high. Imagine going to a store and seeing the price of the item you want go up and up. You might say, “I’ll wait until the price drops.” Then you go back in the next week and the price has gone up even more.
Frustrating. Then you buy the item and go in the following week just to see if there were any price changes. To your dismay the item is now on sale for 50% off. (I would love to get a chance to get into the market at a 50% discount but it may never happen.)
Now what do you do? Cry. Tell yourself you’re a horrible “item buyer” and never buy another item.
Or do you say, “Great, I’ll buy a bunch of these items at a discount so it will last me the next decade.”
Which type of investor are you? Would you look at a price decline as a fatal investing error or an opportunity.
I found the answer to this question usually depends on the percentage of investable assets that are currently invested. If you have $100,000 currently available to invest but you only have $20,000 of that sum invested, then you’d invite a broad decline in stocks. You have a large portion of your portfolio that can go to work. The opposite is true if you’re 100% invested.
When you ask yourself if you should invest when the market’s high, it’s not as easy as a yes or no answer.
It makes financial sense to put your money to work and keep it invested for a very long period. It makes behavioral sense to be careful when putting your money to work in a high market. You wouldn’t want to invest, get scared and then withdraw all your money.
But are markets really that high? I mean, who’s to judge if a market is high? Compared to what? Looking at the absolute numbers can be really misleading. If the DJIA is at 20,000, is that high? What if all the stocks that made up the DJIA earned $2,000 in earnings? A P/E of 10 on the DJIA is hardly high.
I found the best number to use to judge whether the market is too high or too low is the Cyclically Adjusted Price to Earning Ratio (CAPE), Shiller PE Ratio, or PE 10.
This measure is great because it’s adjusted for inflation and you don’t have to worry about using absolute values – just ratios.
Chart: courtesy of http://www.multpl.com/
So what does a CAPE of 33 actually mean? Is it high or low? Well, based the long term average of 16.71, it’s high. But that doesn’t mean it can’t go much higher.
The CAPE was almost 45 at the end of 1999. And we all know what happened after that – a precipitous drop in the market led by internet stocks.
The CAPE was 15 during the Great Recession in 2009. That time frame has proven to have been a great time to buy riskier assets like stocks.
If you’re looking to invest your money when the market’s high (based on the CAPE, not absolute values), it makes sense to have a strategic plan.
1) Make a plan to step into the market slowly. This is especially important if you’ve been keeping your money in cash over the past few years and nervous as to whether you should get into stocks. You may be the type of person who sells when the market goes down which would compound your loss.
2) Don’t just dump all your money into a bunch of stocks or funds you know nothing about. Understand what type of investment (individual stocks, mutual funds, index funds, ETFs) you’re going into and why. Why are you picking mutual funds over index funds? There may be a justified reason. Talk to your fee-only financial advisor about this.
3) Understand your investment fees and expenses. What’s the published expense ratio of your funds? Are there front end fees like 12-1b fees? Do you have enough money to invest in individual stocks or would buying an ETF make more sense?
You have to ask yourself these questions when you’re investing money when the market’s high. It’s not that you shouldn’t get your money to work, quite the opposite in fact. It’s just that there are many risks that you take on when you go into the market when it’s high. Are you willing to take the risk?