It’s good news when the stock market hits a new high, right? Well … maybe, but it might not seem like it if you are about to put money to work in the market , considering how to invest ongoing savings, or even making a switch from one asset class to another.
If the market has gone up there’s a powerful behavioural tendency to think it might go down soon, maybe we’d be safer waiting for a pullback before getting invested. You’re probably seeing headlines like “frothy” or “overdue a correction”. Unfortunately this thinking misunderstands markets and gets it all wrong. Everyone can get on board with the idea of buying stocks after they’ve just fallen and gotten cheaper (in theory anyway) but let me talk you through why you should be happy to invest at all time highs- which statistically is a far more likely scenario to be faced with.
The market just doesn’t obey physical laws and isn’t subject to gravity. As much as it is so tempting to map our intuitions from the physical world into the markets, this is a fallacy. Hard science doesn’t apply. There aren’t any iron rules for how it works – if there were everybody would be following them.
Competing narratives abound in markets all the time , but never more so than at a new high. Smart-sounding people have, and always will, make headlines with compelling sounding arguments for bubbles, euphoria and over-valuation (a secret: fear sells). The most valuable advice you might ever read is to ignore them. Just take a look at how badly you would have fared if you heeded the doom-mongers on this over the last decade.
Historical market performance following all time highs is not that different to overall performance, that’s the reality. Data on the S&P500 since 1950 shows that mean performance in the five years following an all-time high is 3% HIGHER than the average 5 year return.
JP Morgan find that returns following all time highs have been HIGHER than average since 1988:
A reticence to invest at an all-time high is often driven by a fear that this high will be quickly followed by a selloff (meaning potential regret if we invested only to see our portfolio quickly fall in value). But this is an example of results-oriented thinking, and you shouldn’t let this sway your decision as you can’t know in advance if this will happen or not.
The market actually spends quite a lot of time (around 40%) at, or near, all time highs, so it isn’t an exceptional event and really shouldn’t affect your decision making.
Statistically, following trends (ie BUYING at new highs) is actually a very effective strategy in the long term (some respected data analysts have shown there is a hundred years of evidence of this). It’s just as effective as being a contrarian (and selling at highs), although the latter is behaviorally far more tempting.
One way to think about this (from Of Dollars and Data) is that an all-time high signals a lot of willing buyers out there in the market, which is not a bad thing at all for the market’s immediate prospects. Data (again illustrated by Nick Maggulli) shows that all time highs are much more often followed shortly by new all time highs than they are followed by a long pullback (though it’s the ones followed by falls that live long in the memory of course).
Taking the long view
Overall, it’s the decision to be invested in the market that matters (zoom forward and think what you want your portfolio to look like in the future – say 5 years) you can probably imagine this with a good amount of confidence, it tends to be the short term that makes us more uncertain of what to do.
Set your long term perspective – in 20 years will it even matter if you bought at all-time high today and saw a 10, or 20% decline?
Balance regret risk – while investing at a high might be followed by regret at not having waited if the market subsequently fell, you have to balance this against the regret of not investing and the market continuing to climb. These are both pretty much equally likely so you just can’t win that one. In fact, while a new high is not at all guaranteed to be followed by a pullback , it is pretty certain it’ll be followed sometime by another new high. One that you might miss out on if you don’t get invested.
As Peter Lynch said:
Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.Peter Lynch
Dollar cost averaging into the market is a empirically hugely powerful strategy, and even beats a competing strategy of buying the dips with perfect future knowledge. Market timing is an extraordinarily bad game to try and play.
So – cut your investment into tranches to get yourself unstuck and moving without feeling like everything is riding on a single day.
Will the market crash? The market always crashes …
If you liked this you might also like why FANMAGS stocks are under-owned.