With the markets at all time highs, is this a good time to invest?
I hear this question a lot lately. People see the markets are up and yet there are a lot of concerns – China, Brexit, Trump. The list goes on. One new client put her sizable 401(k) into cash recently when a friend who works in finance told her the market was about to crash – it was already down and she missed out on the rebound.
A lot of people are so focused on perfect timing that they fail to act. Worse, they wait and can’t stand waiting any longer as they see everyone else making money; they jump in just at the wrong time.
Finance people will tell you it’s always a good time to invest. This is patently not true. But it’s only clear in retrospect that the market was poised to drop. Even when it seems fairly clear that the market is overvalued, it can remain at lofty levels for a long time. Moreover, investments don’t lose value simply because they are high; sharp declines are usually coupled with some combination of rising interest rates and declining corporate earnings, which are difficult if not impossible to forecast reliably.
This is not to say that certain sections of the market should be avoided or under-weighted at any given moment. Last year, these included biotech companies. Early this year, high-flying growth stocks took a hit. Currently, a number of metrics suggest that utilities, among other sectors, may be overvalued.
Yet the old saw that Wall Street climbs a wall of worry is true. When everything appears rosy, that is actually the time to be most concerned. That happened in 2000 when the dot-com crash occurred and again in 2007-8 when the financial crisis hit. Very few people avoided getting swept up in the manias and fell for the most dangerous words in investing: “This time is different.”
Does that mean a sizable amount of cash should all be invested right away? Not necessarily, though if you have many years to wait before needing the money, it might not be a bad idea. However, for many, the prospect of taking a big loss even just on paper may be too painful.
Sometimes, there are judicious ways to weave cash into the market, for example by spending the money down somewhat to be able to divert salary into tax-deferred investments such as 401(k)’s, 403(b)’s and IRAs. Then you at least get the tax advantages of these accounts no matter what the market does.
A bigger question than when you should invest is how you should invest, and this is more easily answered. When it comes to saving for a specific goal, a good rule of thumb is that funds that you expect to need in less than two years should be kept in cash; money needed in two to five years can be held in bonds; and savings needed five or more years in the future might be invested in stocks.
When it comes to assets that you will need to tap in retirement, however, it pays to be more conservative. Most people should NOT be 100 percent invested in stocks when they are five years or more away from retirement. Retirement spending is different than a home purchase or dream vacation, which can be scaled back if investments do poorly.
A good part of retirement spending consists of non-discretionary items such as food, shelter and health care. For retirement, it’s not good enough that stocks will PROBABLY be higher in five years. To handle these necessities, you will likely need a healthy amount of bonds for their stability and maybe even some cash to handle roughly the first third to one-half of your retirement (using a conservative assumption that you will live to a ripe old age), with stocks providing the boost that allows your budget to withstand inflation in your later years.
Take heart, though. If you invested in all the stocks in the Dow Jones Industrial Index at the market peak in 2007 before the financial crisis, today, with dividends reinvested, you would be ahead by 62 percent, or 5.7 percent annualized. As long as you held on and did not sell.
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