By Justin Pritchard, CFP®
It’s great when the market goes up, but a strong stock market can make investors nervous. Understandably, people worry that whatever goes up must come down, and a market reaching for new highs must be about to head south.
You’ve probably heard that you’re supposed to buy low, and you may have even trained yourself to see weak markets as a buying opportunity (well done!). So, what are you supposed to do when the markets just go up?
The answer, for most long-term investors, is probably “whatever you were doing before.”
But let’s clear this up early: Things could go horribly wrong this time, so see the disclaimer at the bottom and make your own decisions.
Ditching the Herd
An awareness of change and the resulting desire to ditch a herd mentality is often called contrarianism. When contrarians see everybody panicking like it’s 2008, they realize that this too shall pass, and they might even buy more stock. They may say “the stock market is on sale” or similar.
That’s often a good reflex — to not go with the herd — when it comes to investing.
Even when the markets go up, herd mentality can be dangerous. Investors in the tech boom (and every other bubble in history) eventually lost money. 1999 couldn’t last forever.
When emotions like irrational exuberance drive the market, it’s best to stay away. But it isn’t always the case that emotions are driving the markets. Sometimes, markets rise because stocks are worth more: Profits grow, and the long-term prospects of companies improve.
The market is supposed to go up over the long term. For decades, that’s primarily what it’s done — with plenty of crashes and head-fakes along the way. That bumpy road is the justification, or the price of admission, for those higher returns that we expect out of the stock market. We can’t expect to get high returns unless we’re putting money at risk.
Between 1995 and the end of 2015, the S&P 500 with dividends reinvested returned roughly 9.5% average annual returns. Of course, we never know what the future brings, and past performance offers no guarantee of future results. That “average annual” return includes years when investors suffered substantial losses and years when they did very well. There is probably not a single year in which the market returned exactly 9.5%.
Want to zoom in on the financial crisis? The market returned roughly 6.14% per year between September of 2007 (just before things got bad) and the end of 2015. Buying at that "peak" is better than a sharp stick in the eye, although the volatility in 2008 was a very unpleasant experience.
The questions to ask yourself are:
- Are you a long-term investor? Are you investing for a goal that’s 10 years or more in the future? If so,
- Do you believe that things will not change substantially (that is, do you think that the market will continue to go up more than it goes down in the future, that businesses will continue — for the most part — to innovate and grow)?
If you answer yes to both of those questions, you’re probably a long-term investor (and perhaps cautiously optimistic). So, how should you invest? Invest in the same way you would if you weren't paying attention to the markets.
For long-term investors, it’s often best to ignore the ups and downs of the market. Instead, focus on your plan, and make sure that your money is well-diversified according to your risk tolerance. That’s it. Don’t worry about the market reaching new highs — it’s supposed to do that. The market can never be too high to invest if you expect continued expansion (and timing the dips is no small task).
If you’re a short-term trader, you’ve come to the wrong website for information, but there are some safe investments described below if you insist on investing differently when the market seems high.
For long-term investors, the best course is to continue investing according to your plan regardless of what the market does. You’re buying high this month, but the market might continue upward, and you’ve been buying low in other months. It should all come out in the wash.
What About a Lump Sum?
You might be on board with long-term thinking when it comes to small, monthly contributions to your retirement plan. But what about a large lump sum of money — an inheritance, your bonus, or proceeds from selling an asset?
Those one-off situations require careful consideration, but that doesn’t mean you should hold off on investing when markets have been rising.
Again, ask yourself the questions above. Next, do an honest assessment of how you would feel and react if the market fell immediately after you invested all of your money (nobody would appreciate that). With that information, make a strategy.
You don’t have to invest everything all at once — but it’s dangerous to try to time the market. Instead, make a plan and stick to it. Yes, that’s boring, and that’s how it’s supposed to be.
Let’s assume you have a lump sum of cash and:
- The money is not currently (or wasn’t just recently) invested in the markets, and
- You have determined that the money should be invested in the markets (because you’re hoping for more growth over the long-term)
One solution is to set up a systematic investment schedule to invest that money over several months. You could even invest over a few years, depending on how much it is and how worried you are — but remember that there’s a tradeoff to every decision you make.
If you move quickly and invest the money immediately or over just a few months:
- You’ll suffer larger losses if you invest aggressively and the market goes down in the near-term.
- On the other hand, you’ll be on board if the market continues higher over the near term.
If you move slowly and invest small amounts each month, taking a year or more to get fully invested:
- You’ll miss out on potential gains (opportunity cost) if the market moves up before you get invested.
- On the other hand, you may get to buy at lower and lower prices if the market goes down during the time you’re investing.
Which is best? It depends on what happens and your ability to tolerate losses (whether actual losses or missed opportunities). A recent study by Nick Maggiuli shows that it might just make sense to invest your lump sum if you're a long-term investor.
Whatever you do, it’s best to set up a well-defined strategy and follow it. If you decide to invest over the next 12 months, automate those investments so that you don’t have to deal with the logistics every month and — more importantly — you’re not tempted to make changes every month.
Where to keep the safe money: Especially if you plan to hold cash on the sidelines while moving into the market slowly, you need to decide how to invest the "safe" funds. You can leave that money in cash, but it probably won't earn much (and that might be acceptable if you're more concerned about market losses). Moving a step up farther into the risk spectrum, you could include short-term, high-quality bond funds, which might pay a bit of interest. However, bonds can also lose money, and you may have trading costs and capital gains to contend with as you sell the bonds periodically.
If you choose to invest any differently while markets are rising, several investment options are typically considered safe. But remember you may be taking different risks, such as the risk of missing out on gains and the risk of losing value to inflation. You can eliminate market risk in FDIC-insured accounts, but you need to trade that risk for something else.
Waiting for Things to Cool Down
When the market is rallying, it’s tempting to delay investing and wait for things to settle down. Unfortunately, that’s almost impossible to do correctly. You need to be right about two things that are extremely difficult to get right:
- You need to be correct that this is a high point and a crash is coming.
- You need to pick the right low point and decide when to get in (in the future).
If you’re a long-term investor, this is not only difficult — it’s nerve-wracking and unlikely to succeed over numerous market cycles. You might get lucky once or twice, but you might not. Several studies have shown that it’s not so bad to invest at the high point each year (as if you could be so unlucky to invest at the market high every year). Sure, you might earn a little less, but you’ll probably do better than the market timers. And you’ll be investing, which is what your plan said you’re supposed to do.
The great investor Peter Lynch may have said it best:
“Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.”
Note: A “correction” is another term for a stock market crash — or market weakness following strong markets. The term suggests that the market was out of line going up so high, and it needs to get back to more reasonable levels. Saying the market is too high to invest is the gateway to market-timing.
Now that you know what to do when the market is high, prepare yourself for the next time the market goes down.
Just because it’s the disciplined (and often sensible) thing to do doesn’t mean it’s always going to turn out well. If you read this and invest money in the markets, you might lose money. Don’t invest if you can’t afford to take that risk. Murphy’s Law says: This time, for you, in particular, things could go well or badly. So, proceed with caution.
Want some help investing in a complicated world? Let’s talk about your needs and formulate a plan. I can provide guidance on an hourly or flat-fee basis, or I can handle your investments for you if that’s what you prefer.
Get Your Free eBook!
See critical big-picture retirement concepts illustrated in charts — explained in plain English by Justin Pritchard, CFP®. Complete with an overview of the most important aspects and takeaways you can use to improve your chances of success. In PDF format.