Concerns about market downturns certainly come as no surprise. After all, steep corrections and crashes can be alarming for even the most steely and disciplined investors. So, when markets reach all-time highs, investors tend to be concerned about investing their hard-earned money in overvalued stocks. Questions about reducing or even eliminating equity allocations or keeping excess cash on the sidelines soon follow. While these lines of inquiry are completely natural—no one enjoys buying high and selling low—we believe that every day is a good day to invest no matter what the market has done recently.
One of the critical keys to investing when “the market” is at an all-time high is to ensure that your portfolio is not invested only in asset classes represented by benchmarks popular in the news, such as the S&P 500 or the Dow Jones Industrial Average. Diversifying among various sources of risk serves as a hedge against placing too much wealth in one risk basket. While a portfolio built to mimic the S&P 500 or the Dow, which are both concentrated in large-cap U.S. stocks, might rightfully cause concern when those benchmarks are at all-time highs, it doesn't necessarily mean that other asset classes or sources of risk are as richly valued.
A well-diversified portfolio is enough to lessen the fear of a valuation-induced correction for some investors, but for others, the fear of losing money invested at a market high is another hurdle to clear. 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 to your goals that considers 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 has arrived? Consider the following: From 1926-2019, the average annualized compound returns for the one-, three- and five-year periods after new market highs (using the S&P 500 as the benchmark) were, respectively, 13.9%, 10.5% and 9.9%. What’s more, bucking conventional thought, the returns for those same time periods following market declines of at least 10% were lower than the returns after market highs (at 11.3%, 10.2% and 9.6%).1 From this data we can conclude that trying to time an entry point for investing cash is futile.
When you decide to enter the market, evidence shows that deploying all your investable assets at once is a superior approach to spacing out the investment over time, a strategy known as dollar-cost averaging.1 Here is one way to think about this concept: If you chose to invest a portion of your cash immediately, and then space out the remaining investments, there now exists inherent tension in answering the question, “Now that you have invested a portion of your portfolio, would you rather that the stock market go up or down?”
Of course, most people would prefer to see the stock market rise after making an initial investment, yet, logically speaking, if the market were to drop, then subsequent purchases could be made at lower prices. But we aren’t purely rational creatures. While the logical solution may be to invest cash all at once, the psychological solution for you may be to space out investments over time. And that’s an okay decision as well, especially if that is what will allow you to advance your financial plan.
1 Data from Dimensional Fund Advisors. “Taking Stock of Lump-Sum Investing vs. Dollar-Cost Averaging.” August 2020.
This information is for educational purposes only and should not be construed as specific investment, accounting, legal or tax advice. Information from sources deemed to be reliable but its accuracy and completeness cannot be guaranteed. Performance is historical and does not guarantee future results. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio nor do indices represent results of actual trading. Total return includes reinvestment of dividends and capital gains.