U.S. stocks are at an all-time high. Vanguard’s Total Stock Market Index looks like a Tsunami on the rise. In the five-year period ending December 26, 2016 it swelled 97.61 percent. If $10,000 were invested in the index, just five years ago, it would have grown to $19,761. That’s just the kind of rise that comes before a crash. Or is it?
New investors have sent me a lot of emails lately. They’re afraid to invest. But this is worth knowing. Stocks are always hitting new all-time highs. I’m 46 years old. Over my lifetime, the S&P 500 (with dividends reinvested) has hit all-time highs during 30 different calendar years. I’ve listed them below.
Years U.S. Stocks (With Dividends Reinvested) Hit All-Time Highs
|Source: NYU Stern School of Business|
During those years, what did the headlines say? Many said stocks were going to crash. Most of them were wrong. Forecasters who got lucky were almost always wrong the next time. Nobody can predict when stocks will rise or fall. That’s why Warren Buffett says stock market forecasters exist to make fortunetellers look good.
Vanguard published a report that looked at popular metrics used to predict stock market returns. Researchers Joseph Davis, Roger Aliaga-Díaz and Charles J. Thomas looked at data from 1926 until 2012. They examined price to earnings ratios; cyclically adjusted price to earnings ratios; trailing dividend yields; corporate earnings growth trends and a consensus of predicted earnings growth. They also looked at five different measurements of economic fundamentals, followed by three different multi-variable valuation models.
They agree with Warren Buffett. The researchers reported, “Stock returns are essentially unpredictable at short horizons…this lack of predictability is not surprising given the poor track record of market-timing and related tactical asset allocation strategies.”
More important, you’d actually be better off without a soothsayer. Here’s an example: Assume you were a new investor in 2008. While playing in a sandbox you found Alladin’s lamp. You rub that lamp and a genie appears. He says, “This year you’ll see the worst stock market drop since 1929.”
Frightened by the forecast, you decide to wait for stocks to “stabilize.” You add $200 a month to your bank’s savings account. If it paid $100 in interest (that’s a pipedream) you would have accumulated $4,900 by January 2010. That’s when you put the proceeds into Vanguard’s Total Stock Market Index Fund (VTSMX).
If you continued to add $200 a month–putting the proceeds into the index–you would have a total of $38,004 by November 30, 2016. Thank God for genies. Morningstar’s Russel Kinnel reported that the average mutual fund dropped 30 percent in 2008. You sidestepped that mess.
Now let’s imagine (this part isn’t hard) that you never met that genie. You didn’t know that stocks were going to fall. You invested $200 a month into the stock market index starting on January 2008. Stocks crashed. But you just kept adding $200 a month. By November 30, 2016 your portfolio would have been worth $39,926. In other words, you would be almost $2000 richer than if you had actually met that genie.
But what if you have a lump sum to invest? Let’s say it’s $500,000. With U.S. stocks at an all-time high, you might be afraid to invest that money. You might be tempted to wait until stock prices are lower. If that’s the case, human emotions are taking you for a ride.
Consider the question from a different angle. If you had been investing for years and you had accumulated $500,000 in your IRA, would you sell everything and wait for stocks to fall? You probably wouldn’t. But that’s exactly the same as waiting to invest. By jumping out of stocks (or not getting in) you could miss some big gains.
The S&P 500 averaged a compound annual return of 9.85 percent between January 1995 and December 31, 2014. That would have turned a $10,000 investment into $65,475.
Investors who missed the best five stock market days would have averaged a compounding return of just 7.62 percent per year. Instead of seeing their money grow to $65,475, they would have ended up with $43,435.
By missing the best 20 days, this money would have grown to just $20,360. Investors unlucky enough to be out of the markets for the best 40 days would have lost money. Their initial $10,000 would have shrunk to $9,143.
U.S. stocks hit an all-time peak in 1989. They had gained 279 percent during the previous ten years. Forecasters were likely calling for a crash. But anyone who sold (or decided not to buy) might have missed the market’s new all-time highs in 1991, 1992, 1993, 1994, 1995, 1996, 1997, 1998 and 1999. In the nine years that followed 1989, stocks gained another 316 percent. Nobody but Pinnochio saw that coming.
So, if you’re just starting to invest, get going right away. Build a diversified portfolio of low-cost index funds. Include a U.S. index, an international index and a bond index. Or buy one of Vanguard’s Target Retirement funds. If you have a lump sum to invest, do the same thing right away. Magic genies don’t exist. Statistically speaking, the best time to invest is as soon as you have the money.
Andrew Hallam is a Digital Nomad. He’s the author of the bestseller Millionaire Teacher and Millionaire Expat: How To Build Wealth Living Overseas