In 2015, a friend remarked that she was selling some of her stock investments because the market had gone up so spectacularly since the 2008 decline. She figured that we were due for a reversal and wanted to protect herself from losses.
Five years later, the market is still going up. Despite a slight drop in 2018 and a dip in 2020, markets continue to rise.
My friend is a perfect example of how difficult it is to predict market movements — and how tricky it can feel to invest in stocks. In fact, the stock market has traded up for years, even after financial ratios implied it was overvalued.
This recent stock market run up has left many “value” investors scratching their collective heads, as momentum strategies continue to outperform.
While the market continues to soar, how should you invest in stocks? Should you dive in now or wait until later — when valuations have returned to “normal”?
It’s Always the Right Time to Invest in Stocks…
Glancing at historical stock market charts, the stock market trend is upwards, with periodic declines along the way.
“According to Ibbotson Associates data, since 1926, a portfolio of large stocks has had a positive return in 69 of 94 years, or 73% of the time,” says Robert R. Johnson, chair and CEO of Economic Index Associates.
Would you invest in stocks with 3-1 odds that the market will go up?
Most folks would consider that a good amount of risk.
But what if during the down year you could lose 30%, 40% or even more. That makes staying the course somewhat scarier.
Since 2000, we’ve had some serious declines in the S&P 500. At the turn of the century there were three years of losses. Next, in 2008, the market fell 36.55%.
Yet, despite the losses, the S&P 500, including reinvested dividends, returned roughly 255% between Jan. 1, 2000 and Aug. 31, 2020. That translates to an annualized return with dividends reinvested of 6.5%.
Market Timing: Ways to Avoid the Market Declines
There are cadres of investors with “beat the market” strategies. There’s the technical, chart-studying investor with strategies to outperform the S&P 500. In fact, the Investors Business Daily print periodical and website at Investors.com were built on market-beating strategies.
Market timing is difficult. If you miss a few trading days a year, your returns will suffer.
For example, $10,000 invested in the S&P 500 on Dec. 31, 2004 would be worth $36,418 on Dec. 31, 2019, 15 years later. That is a 9% annual return.
If you missed the best 10 days during that 15-year period, your return is nearly halved to $18,358 for a 4.1% annual return.
Miss the 30 best days and your $10,000 investment declines to $8,150 for a 1.35% annualized loss.
“Many people have been preparing for a recession for years and exited the stock market. The opportunity cost of such a strategy is quite high. These folks sacrificed strong gains in the market for the past few years while they have held cash,” Johnson says.
In the March 2020 report, “Quantitative Analysis of Investor Behavior,” research firm Dalbar found that between 1989 and 2019, the typical U.S. stock market mutual fund investor underperformed the market by approximately 5% by moving in and out of the markets. Dalbar estimates that the typical investor earned 5.04% annually versus an S&P 500 annual return of 9.96%.
Market timing is a fool’s errand and exceptionally difficult. Most market timers fail to beat a passive index fund investment approach.
Reasons to Invest in Stocks
Assets are valued in relationship to other assets, not in isolation. Your alternatives to investing in the stock market are limited. Bond and CD yields are at all-time lows. Commodities lack dividends. Real estate is a possible alternative, although buying real property has a high barrier to entry. That said, investors can purchase real estate stocks through REITs or real estate trusts.
When considering the alternatives, the yield on the S&P 500 is 1.71% while the 10-year Treasury yield is 0.67%. It’s clear, on yield alone, the stock market offers a higher yield and capital appreciation.
Some investors use the earnings yield ratio to compare stock and bond investing. The S&P 500 earnings yield calculates the underlying S&P 500 companies’ earnings for the past year and divides it by the S&P 500 index level. The result is then compared with the 10-year Treasury yield.
The current S&P 500 earnings yield is 4.5% — that is significantly higher than the Treasury’s 0.67% yield.
Currently, both metrics favor equity investing over bonds.
The Federal Reserve has indicated that it will maintain low interest rates. Lower interest rates translate to low borrowing costs for corporations, and subsequently, lower costs can help profits. Greater corporate profits typically translate into higher stock prices.
Another factor in favor of stock market investing.
Is Now a Good Time to Buy Stocks?
The data suggests that it is better to invest in stocks now than wait for a drop — or for the perfect entry point.
There’s never an “ideal” time to invest. If you believe that U.S. and global companies will continue to profit in the future, then now is a good time to invest.
That said, do not invest in the stock market with any money you anticipate needing within the next five years or so. Stock market returns are higher than the alternatives due to the risk of loss. Over short periods of time, markets can and do decline.
Long-term investors have enjoyed growing returns in the stock market. It is likely that this trend will continue.
On the date of publication, Barbara Friedberg did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Barbara A. Friedberg, MBA, MS is a veteran portfolio manager, expert investor, and former university finance instructor. She is editor/author of Personal Finance; An Encyclopedia of Modern Money Management and two additional money books. She is CEO of Robo-Advisor Pros.com, a robo-advisor review and information website. Additionally, Friedberg is publisher of the well-regarded investment website Barbara Friedberg Personal Finance.com. Follow her on twitter @barbfriedberg and @roboadvisorpros.
