How to Approach Investing in an "Overvalued" Market
One of the most common questions our office has received over the past few months is something along the lines of:
Is now really a good time to be investing in stocks? I’ve heard the market is really overvalued.
It’s a fair question given the stock market’s strong run over the past 8 ½ years. Since the market bottomed out following the Financial Crisis in March 2009, the S&P 500 has gained more than 246 percent. That’s an annualized return of 17 percent/year before dividends. Over the past 50 years, the average annualized return is closer to 8 percent/year. At the time of this writing, the S&P 500 sits just below its all-time high of 2594, which was set just 2 weeks ago! The S&P 500 and other popular benchmarks have continued to set new record highs all year. Right now, a quick Google search for “stock market” AND “overvalued” yields 555,000 results.
Historical data suggests these recent returns likely aren’t sustainable in the long run. At some point things will slow down and we’ll even experience another downturn. The difficulty is predicting when these types of market events will transpire. In fact, it’s almost impossible to do so.
Most investors, particularly those new to the investing process, grow more cautious as the market rises. They start asking questions and wonder about how they should navigate future market decisions.
The market is bound to crash soon, should I get out now?
I have some money to invest, but I can’t do it now because the market is so high.
Fortune Magazine recently published a piece titled “Top Economist: Get Ready for a Stock Market Drop.” The article offers data, perspective and a strong argument suggesting this current bull market has run its course. Looking at a 10-year chart of the S&P 500 in relation to the date of this article (see below), it sure looks stocks are due for a bit of a correction.
The author of this article might very well be correct. Perhaps the strong market run in 2017 is simply the last gasp of a cyclical bull market rally? Of course, no one knows. Even the sharpest, most experienced investing mind in the world has no better idea about future market movements than the novice investor trying to understand the difference between a stock and a bond.
There’s an obsession in the financial media during bull markets to predict the next downturn, probably because contrarian views sound smart and seem to demonstrate superior knowledge and perspective. Several times over the past 10 years, we’ve heard warnings about the market being overvalued and due for a drop. I’ve attached some of these links below and noted their timing on the S&P 500 chart over the past decade:
Imagine basing important investment decisions on those types of predictions? You would have missed out on some significant investment returns. The best practice to approaching market valuations is to adopt an investment strategy that almost ignores them altogether. Implement a system that isn’t at all dependent on timing the market. Instead, focus your attention on your cash flow, time horizon and any needs that you might have from your portfolio in the near future. Once you have good perspective on these items, any concern around market valuations should subside.
For example, if you know that you need a certain amount of money to buy a house within the next year, that money probably shouldn’t be in the stock market in the first place. But if you’re simply a long-term investor trying to grow your wealth or save for retirement, short-term market swings shouldn’t be keeping you up at night. The overwhelming evidence suggests that consistently saving money into a diversified portfolio – through market rallies as well as downturns – is the strategy most likely to succeed in the long run.
The irony of younger investors being fearful of an impending stock market downturn is that most of these same investors would benefit tremendously from such a decline. Net savers – which includes just about everyone in their 20s, 30s and 40s – should welcome a material correction in current stock market prices. All it would mean is that stocks go on sale, which is generally a good thing when you’re in buying mode. The only time you want the market to rally is at the end of your investing career, preferably right before you retire.
The bottom line is that markets are volatile and involve certain levels of risk. We know that over long enough periods of time, markets move in a positive direction. Benefiting from this upward trajectory requires enduring shorter periods of pain and uncertainty. Adopting a systematic approach to saving and investing should help alleviate market-timing concerns. Make investment decisions based on YOUR schedule, with full perspective of YOUR financial needs. At the end of the day, it’s a much better strategy than navigating the market based on headlines and speculative predictions.