One of the biggest questions on everyone's mind is if they should buy stocks now. When times are great, and the stock market is at all-time highs, people often worry about an impending crash. They are concerned if they buy stocks now, the stocks will crash.
Another group of people wonders if they should buy stocks when markets are down. Usually, when there is bad news, people worry that there is worse news in the future. And they hesitate to buy stocks.
Historical Returns of Stock Markets
The chart shows the US stock market return over the last 100 years. The shaded areas indicate recessions. During the 100 years, we have experienced two devastating World Wars, several pandemics, Black Monday, high inflation, the Japanese crash, the Dotcom crash, the Housing Bubble, and several other shocks to the stock market. Despite all the horrible economic events, the market has continued to march upwards over a long period.
Of course, the climb higher has not been without setbacks. The chart also has extended periods of drawdown. After the crash in 1929, the index broke even only after 30 years. Similarly, after the peak in 1965, the index took approximately 30 years to reach the same level again.
Thirty years is a long period to wait and watch, hoping to come back to break even.
I can understand why everyone gets nervous buying stocks at all-time highs, wondering if this is the ultimate top. The biggest challenge in answering “should I buy stocks now” is what are the alternatives.
Not Many Alternatives To Investing
- Sitting in cash: In the past, when interest rates were higher, money at least yielded a positive return. With interest rates now at rock bottom, waiting in cash for an extended time is a losing proposition. Inflation would eat up your principal. Even if you keep all the money under a mattress, the cash loses value by approximately 2% a year. In the short term (1-3 years), staying in cash might not hurt your net worth a lot. But over a more extended period, your cash's loss of purchasing power will be very high. Over 25 years, cash has underperformed the US stock market.
- Markets may not get lower: Before the pandemic, many “experts” on TV assumed stock markets were high. After the crash and the subsequent rebound, the markets are now at higher levels. So if you had waited in cash in 2019, you are still not seeing those price levels in 2021.
- When to buy: Assuming you are sitting in cash waiting for the crash to buy stocks. How would you be able to identify a crash? Even legendary investor Warren Buffet was unable to time the fall during the pandemic. He believed, as did many others, that stocks would go much lower. They never did. And this is why timing the market is challenging. The adage “time in the market” is better than “timing the market” holds.
I also do not want to dismiss anyone's concerns with buying stocks. However, there are several factors to consider which help us avoid questioning if one should buy stocks now.
Acknowledge The Volatility
Stocks are volatile. Volatility is a feature of the stock market, and there is nothing you can control. You can diversify based on size (small cap versus large cap), quality (growth versus value), region (local versus international), sector (technology versus utilities), etc., but at the end of the day, in case of an economic shock; all stocks will decline. It is rare to see in a recession where diversification within the stock market can help you.
Figure Out Your Pain Threshold
It can be hard to see your stock portfolio cut in half. During the housing crash, I was overweight in financial stocks. It was not easy to watch most of them drop by 50%, and some, like Lehman, even went bankrupt.
The worst thing you can do in a crash is to let your emotions take over and panic sell. Therefore before you invest in stocks, you have to understand your psychology. And define your pain threshold. Some individuals stay calm if the stocks fall by 80%. Others will panic watching a 10% drop. You have to know yourself and make a plan before it happens. Acting on emotions in the heat of the moment is never a good idea.
Always have a written plan in advance.
Define Your Time Horizon
The 100-year chart shows that in some instances, after a fall, stocks did not regain their original levels for 30 years. However, if you held on to your stocks and kept dollar-cost averaging, you would be handsomely rewarded.
Since stocks are a vehicle for long-term growth, do not buy stocks with the funds you need in the short term. For example, if you want to buy a house in the next two years, do not invest your down payment in stocks. You could get lucky, and the market may go higher in the next two years. But what would you do if the market drops?
Similarly, as soon as your child is born, you could buy stocks in the 529 plan, but as your child gets older, reduce your stock exposure gradually so you have the funds available for your child's education.
You can follow a similar long timeline strategy using stocks in your retirement portfolio. Since retirement is usually 30 years away, start with an aggressive stock allocation and taper it down as you are closer to retirement.
Diversify With Other Assets
Asset allocation involves balancing risks and rewards in your portfolio by investing in several different assets. The purpose of adding assets besides stocks is that when stocks are down, the other assets can help stabilize the portfolio.
When we analyzed the best-performing stocks, it was apparent that a diversified index fund was a better approach for most investors. On a risk-adjusted basis, stocks have provided excellent returns. However, the return comes with a price. Stocks are volatile.
As part of a prudent investment strategy, develop your asset allocation plan first. Evaluate various income-producing assets based on ranking the anticipated risk and volatility, anticipated return, liquidity (how easy is it to sell and get our money back), passive nature, and availability (can anyone buy it).
Real estate or bonds can help reduce the volatility you experience with an all-stock portfolio.
In the current environment, bonds offer little to no return, but real estate still provides handsome returns. Although real estate typically requires more money than a typical stock, you can still invest in real estate with little or no money. If you prefer a hands-off approach, real estate syndication could be the answer.
Ignore Stock Prices
Although you have a well-defined asset allocation plan and diversified assets, it is hard to get away from the constant barrage of stock market news. Every news outlet or newspaper talks about economic conditions. The flurry of stock market news tempts us to act on either buying or selling immediately.
Resist the urge to act based on the news!
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
Fidelity reportedly conducted an internal study to review performance on accounts that did the best. They found that the best-performing accounts were from investors who were either dead or had forgotten they had accounts with Fidelity.
The takeaway message from the study is that the best investors ignore stock prices. They never worry if the stock market is too high or too low.
Instead of timing the market, focus on time-in-the-market. The best way to avoid market timing is to invest regularly in the stock market.
Define how much you want to invest periodically and invest the same amount every pay period.
Automate your investment and treat investing like a bill to be paid. Irrespective of the stock market levels, high or low, have money automatically deducted from your account and invested. With the FinTech revolution, several free automated investment platforms are available for you. Use a set-it and forget-it approach.
Final Thoughts On Should I Buy Stocks Now
Lately, the stock market has been hitting all-time highs. Based on the Schiller PE ratio, the market has only been more expensive once in the past, in 1999.
I am sure reading this statistic makes you question if you should buy stocks now.
However, the Shiller PE ratio is outdated, as are other metrics which worked in the past. After all, if simple formulas worked to inform us to buy or sell stocks, we would all be rich.
The investment world does not stay static. Any metric or strategy which has worked in the past gets arbitraged away and no longer continues to work. The dynamic nature of the stock market is why even legendary investors fail to outperform the stock market over long periods. Yes, even Warren Buffet has significantly underperformed the S&P 500 over the previous 18 years.
In 2020, we had one of the worst economic news. Based on the grim reality facing us and the sudden drop in the stock markets, you would have again been hesitant to invest in stocks. A year later, that instinct would have been proven incorrect.
Bottom line, there are not many great alternatives when avoiding stock investing. A better course of action would be to acknowledge the volatility, define your time horizon for stock investments, develop a diversified asset allocation plan, ignore daily stock news, and automate your investments. You would never need to worry about when to buy and sell stocks. And you would still vastly outperform many other investors.