S&P 500 Chart History

Is Now A Good Time To Buy Stocks?

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In general, whether it’s a friend seeking advice, or a new acquaintance that just discovered what I do for a living, I tend to get asked the same investing questions over and over. Apple comes up a lot. As does Facebook. But by far the most popular question isn’t company specific; it is simply, “Is now a good time to buy stocks?” It’s easy to see why this question is on so many minds. The average cash balance for Personal Capital dashboard users is about 15% of their portfolio, and the S&P 500 is hovering around new highs. So should all that cash remain on the sidelines? Or should it be put to work?

Market Timing – Does It Work?

Before diving into the answer, let’s first consider the question—even the questions about Apple and Facebook, for that matter. They all have one common underpinning: market timing (a.k.a. active management). Said another way, these individuals are trying to decide whether it’s better to invest now or later, and are thereby making an active market call. This isn’t terribly surprising. After all, the financial media is obsessed with market timing. And for good reason, it sells! It’s been engrained in our minds. People want to hear about a hot new stock tip, not a boring buy and hold strategy. Unfortunately, this creates the illusion that anybody can go out and pick the best stock, or call the next market peak—or at least profit by investing with those who can (e.g. investing in actively managed mutual funds).

This leaves the obvious question: does market timing work? Maybe for a select few, but even these individuals can’t get it right every time. And it just takes one bad call to erase all your previous gains. Take Bill Miller, for example, who ran the famous Legg Mason Value Fund (LMVTX). Going back to 1993 (a 20 year period), this fund outperformed the S&P 500 for 13 straight years through 2005. He was hailed by many as a genius. And then it all fell apart. Due to some poor portfolio bets, the fund was devastated in the downturn of 2008, losing over 70% of its value in less than a year and half. By the March 2009 bottom, his fund’s cumulative return was back below the S&P 500’s, despite outperforming the index for more than a decade.

Bill Miller is a dramatic example, but the reality is most active fund managers do not outperform their respective benchmarks. Standard & Poor’s releases an annual study of active mutual fund managers. In their 2013 mid-year report, for the period ending June 30th, 54% of domestic fund managers underperformed their benchmarks over a one year period. Extend this to three years, and almost 79% underperformed! In fact, there is no ten year period in history when a majority of active fund managers outperformed their respective benchmarks.

So if this is a challenge for professionals, why would the average investor be any better? Well, they’re not. Research firm Dalbar conducts a study called QAIB, or Quantitative Analysis of Investor Behavior. The results are clear: individuals are terrible at timing the market and consistently buy and sell at the wrong times. Over 20 years, this caused them to underperform the S&P 500 by about 4% annually. That’s a substantial hurdle to overcome.

The Case for Investing Today

The evidence is compelling—market timing simply doesn’t work for the average investor, as well as most professionals. Yet this is exactly what investors are doing when they sit on cash, waiting for the right time to buy in. Yes, the S&P 500 is hovering around new highs, but this has been the case for most of its history. It closed at a new high in 50 of the last 88 years going back to 1926. Had you stayed on the sidelines at each new high, you would have missed most of its +450,000% gain. Remember, equities have a positive long-term expected return. That means over time it is more probable they will go up than down.

Of course, there is always the possibility of investing right before a market downturn. But no one truly knows with certainty when they will occur. Even if an investor got lucky and avoided a bear market, they still don’t know when to get back in. It seems logical that a 20% or 30% drop would present a valuable buying opportunity, but that isn’t the way most investors behave (see QAIB study above). More times than not, they let psychological biases overpower their decision making. Out of fear, they wait for an “all clear” signal that never arrives. And by the time they’re comfortable again, the market is already well into its recovery and they’ve missed much of the upside.

Some might say all of this uncertainty makes a strong case for dollar cost averaging. This is the process of investing chunks of cash over time to capture periods of depressed market prices (i.e. buying low). There is definitely some logic here, particularly if it refers to investing monthly savings. But the story is different if it refers to an existing pile of cash.

In 2012, Vanguard published a study on dollar cost averaging versus lump sum investing. It found that over 10 year rolling periods, investing cash in a lump sum was 67% more likely to outperform relative to dollar cost averaging. It assumed a mix of 60% stocks and 40% bonds. That’s a significant figure, and it makes sense given the positive expected returns for stocks and bonds. In other words, over longer periods of time, investing sooner rather than later captures more of the upside.

Before You Take Action

So what do I say when people ask me if it’s a good time to buy? It’s almost always a resounding “YES,” regardless of where the stock market sits. This is true even with my personal investments. I never sit on cash unless I plan to use it in near future (or it’s set aside as an emergency reserve).

But before investing anything, it is critical you’ve established an appropriate asset allocation. This will help determine how much of your total investment actually goes into stocks. It is the percentage mix of domestic and international stocks, domestic and international bonds, alternatives, and cash. It is the single most important driver of long-term returns, and it will vary depending on your specific financial situation, goals and risk tolerance. Utilize Personal Capital’s free Investment Checkup tool to help assess risk and establish a target allocation.

Being fully invested in a diversified portfolio can increase expected return while simultaneously keeping risk at a comfortable level. Just make sure to stay on top of your asset allocation to match your risk tolerance over your life time.

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Brendan Erne, CFA
Brendan Erne serves as the Portfolio Management Team Leader with Personal Capital Advisors. He has over 15 years of industry experience, spanning almost all levels of the investment process, including several years at Fisher Investments as an equity analyst covering the Technology and Telecommunications sectors. He also co-managed a large cap growth portfolio and co-authored Fisher Investments on Technology, published by John Wiley & Sons. Brendan is a CFA charterholder.

11 comments

  1. Barbara Friedberg

    Barbara Friedberg

    Brendan, Given the relatively high valuations today, I’d recommend dollar cost averaging into the financial markets. Although, in general, the research does support it’s usually better to invest sooner rather than later.

    Reply
  2. Financial Samurai

    Brendan,

    I love this line, “Yes, the S&P 500 is hovering around new highs, but this has been the case for most of its history.”

    It puts things in perspective that the general trend is up and to the right. Time is an investor’s biggest ally as shown tie and time again.

    Given my experience in the business, I’m very wary of the stock markets and will never ben able to investment more than 35% of my net worth in stocks. What percentage of your net worth is invested in stocks?

    Thanks

    Reply
  3. Brendan Erne, CFA

    Brendan Erne, CFA

    Thanks for the comment Sam. As far as my net worth and stock weight is concerned, I definitely have large percentage invested in equities. I’m very aggressive from a risk perspective, and I have a long time to go until retirement. As such, I can stomach a lot more market volatility. Right now, I have approximately 85% invested in stocks, which is a combination of domestic, international developed and emerging markets. The other roughly 15% is in alternatives (real estate, commodities, gold, etc.) and fixed income.

    It’s important to keep in mind that just because you consider yourself highly aggressive, it does not mean you need to be 100% invested in stocks. By diversifying a little, you can actually reduce volatility and achieve a higher portfolio value over time (than if you were 100% equities).

    Brendan

    Reply
    • Financial Samurai

      Hi Brendan,

      85% is pretty aggressive, which is good in a bull market! I’m more around 30-35% equities, 40% real estate, 25% risk-free if I exclude the value of my business. Let’s hope the good times continue!

      Sam

      Reply
  4. Justin McCurry

    Justin McCurry

    As is often the case for those who are investors, a friend asked “I’m about to invest my 2013 and 2014 IRA contributions in the market right now. Is it a good idea?”.

    My answer was “sure, but you know the market is at an all time high”. Then I followed up with “Do you need the money within 10 years?”.

    She answered yes, and yes. Might as well invest if it’s long term money. And I knew this was a smallish part of her portfolio, so not a huge risk to the overall portfolio.

    Reply
  5. funancials

    It’s always a good time to invest!

    I’m very interested in the DCA vs. LSI investing when it comes to existing funds. In the Vanguard study that you link to, they look at DCA periods of 6, 12, 18, 24, 30 and 36 months. It does not surprise me that this long delay to enter the market leads to under-performance. I wish they would’ve compared the 6 and 12 month DCA strategy against the LSI because I feel like this leads to reduction of downside risk and (potentially) greater returns. But, it’s just a feeling.

    Great article, thanks for writing.

    Reply
  6. Tricia

    One thing to note: You write, “The average cash balance for Personal Capital dashboard users is about 15% of their portfolio, and the S&P 500 is hovering around new highs. So should all that cash remain on the sidelines? Or should it be put to work?”

    I’m willing to bet that that 15% is cash earmarked for short-term use (i.e., house down payment, vacation plans, etc.) or else it’s emergency fund cash. In which case, it definitely wouldn’t go into stocks.

    And if you’re a multimillionaire, it makes sense to me to keep a big chunk in cash anyway. If you don’t NEED to make every penny work hard for you, why risk it?

    Reply
    • Financial Samurai

      Tricia,

      You make a good point. If you are a multi-millionaire, it actually becomes more of a game to maximize the return on your cash. I’m looking at my cash balance right now after paying my latest credit card bill and the total is only $500. It’s thrilling to live on a slim cash margin because it forces me to watch my cash flow and curb my spending.

      If I had mega millions, I’d happily keep more of my NW in cash b/c as you say, I wouldn’t need to make every penny work for me.

      Let’s just hope the bear market doesn’t return and Russian doesn’t bomb the heck out of Ukraine!

      Sam

      Reply
    • Catha Mullen

      Tricia, I took a look at the Personal Captial data and thought you might find it interesting that the 15% cash number is just cash in investment accounts — it excludes bank accounts, which may be more likely where people keep emergency funds. From that standpoint, it seems like a high number!

      Reply
  7. Tintin

    I probably have too much cash (over 10% of my total assets, and probably enough for a few years of expenses, but having it makes me feel more secure, even if that’s a false belief, and I’d be more secure in the future if I invested more of it.

    Reply
  8. Aandelen Hulk

    Very good read. I think that everytime is a time to invest. You just need to look very good.
    Anyway, I’ll see you around.

    Cheers,
    Hulk

    Reply

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