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I was reading recently that markets are overvalued, and came across a term called the 'Buffett Indicator' from Warren Buffett:

The "Buffett indicator" divides the combined market capitalization of a country's publicly traded stocks by its quarterly gross domestic product. Investors use it as a rough gauge of the stock market's valuation relative to the size of the economy.

In summary this indicator points us to the fact that markets are indeed currently over-valued, at least according to Warren Buffett.

What I'm hoping to do soon is finally enter the market with normal best practices in mind: indexes and a well diversified portfolio. However, my instinct is telling me that this is a bad time to get started given market valuations.

I know the common advice is to never try to time the market, but at this time doing so seems more prudent than anything else. Is there any concrete reason why I shouldn't wait?

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    People love to abuse indicators, did Buffett actually say anything about markets being overvalued?
    – Hart CO
    Feb 14, 2021 at 3:34
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    Which country is overvalued? Feb 14, 2021 at 3:36

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(I'll answer in the context of the US market, but the same ideas apply to other markets.)

The US stock market is quite over-valued by many valuation measures. But markets can remain over-valued for quite some time. As you note, you shouldn't be trying to time the market, but you also don't want to do something dumb and lose money.

There is a lot of emotion in investing. Especially for people starting out. Instead of thinking about it as market timing, consider basing your investment strategy on minimizing your regret (unhappiness) of possible outcomes.

For example, if you invest 100% in S&P 500 and the market tanks 50% next month, what is your likely reaction? Some people will be very upset. Some people will be fine knowing that the markets go up in the long term.

If such a market crash would upset you, then consider 50% in S&P 500 and 50% in bonds. You'll lose much less in a market crash. Though you'll also gain less if the market continues to do well. Will you regret missing out? Then put more money in stocks and less in bonds!

Pick an asset allocation that lets you sleep at night.

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Normal best practices include investing a portion of your savings on a monthly basis. This follows the best practice of "not timing the market."

However, if you have a large chunk of money saved up, and you suddenly invest all of it, then in my opinion, both of those actions are guilty of "timing the market." It was timing when you saved a chunk of money in cash, rather than regularly investing it. It would also be timing if you plunged into the market with all of your savings. If you are already guilty of timing the market, it could make sense to use valuation metrics such as the Buffett ratio to decide when to invest.

If guilty of timing and seeking to repent of the practice, you could use a dollar-cost averaging plan to invest the chunk of money that you have in cash. Instead of plunging in, you could plan to invest the chunk in equal dollar amounts over the next 18-24 months. You can also start investing on a regular basis out of your salary, going forward.

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  • I'd note that one of the reasons I'm cash-heavy at the moment isn't because of a desire to time the market, but because I've lacked the confidence to enter it. I'd prefer to be more sure about what I'm doing before I actually buy investment products, which I think is a prudent thing to do. To date I've put considerable money onto our mortgage and in a conservative education fund for our child.
    – Cdn_Dev
    Feb 15, 2021 at 2:02
  • If it wasn't clear, the phrase 'guilty of timing' was meant to be lighthearted. Best wishes. Feb 15, 2021 at 2:21
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A few things.

  1. Warren Buffet is himself bullish right now, but he's cycling money around to newer positions like $VZ, $KR, and $MRK.
  2. The Buffet indicator is just 1 indicator and only takes into account a couple of variables, namely GDP and market capitalization. It isn't forward-looking, but it can be used as a kind of overbought or oversold indicator, similar to an RSI.
  3. It relies heavily on GDP in its calculation, which has been impacted by COVID. The GDP growth that was expected during 2020 didn't happen because of shutdowns and supply chain disruptions. Once there's a resolution to the pandemic, I hypothesize that GDP can grow quickly, which will impact this indicator by a significant amount.
  4. There are several other macro metrics that tell a completely different story than this. For instance, as long as bond interests remain low, investors are incentivized to allocate their cash toward stocks and other market securities instead.
  5. Investors are excited about some recent technology advancements and the earnings that some companies are expected to profit from them, and The Buffet Indicator can't distinguish these advances, nor can it capture the market's attitude toward them. W̶e̶ ̶a̶r̶e̶ ̶i̶n̶ ̶t̶h̶e̶ ̶m̶i̶d̶d̶l̶e̶ ̶o̶f̶ ̶a̶ ̶m̶a̶j̶o̶r̶ This technological transformation t̶h̶a̶t̶'̶s̶ ̶g̶o̶i̶n̶g̶ ̶t̶o̶ will likely impact almost every industry: EV/self-driving transportation, automated manufacturing, advanced energy production and storage, the e̶l̶e̶c̶t̶r̶i̶f̶i̶c̶a̶t̶i̶o̶n̶ implementation of "smart grids", AI that can optimize repetitious tasks and cater advertisement perfectly, maturing CRM solutions and tools, high levels of computational power that can make business decisions more accurately than people. All of these things cut costs and eliminate overhead, but could cause some job-cutting and money velocity disruptions in consequence as well. These are complicated things to accurately predict and quantify, or to integrate these as metrics in a holistic indicator, because they're forward-looking. One way to do so is to consider the amount of expenditures these companies have recently made on R&D, but those costs don't always translate into future profits as expected or in a perfectly symmetric 1:1 way. W̶h̶e̶r̶e̶ ̶i̶n̶ ̶T̶h̶e̶ ̶B̶u̶f̶f̶e̶t̶ ̶I̶n̶d̶i̶c̶a̶t̶o̶r̶ ̶d̶o̶e̶s̶ ̶i̶t̶ ̶t̶a̶k̶e̶ ̶a̶n̶y̶ ̶o̶f̶ ̶t̶h̶e̶s̶e̶ ̶a̶d̶v̶a̶n̶c̶e̶m̶e̶n̶t̶s̶ ̶i̶n̶t̶o̶ ̶a̶c̶c̶o̶u̶n̶t̶?̶ ̶A̶n̶s̶w̶e̶r̶:̶ ̶i̶t̶ ̶d̶o̶e̶s̶n̶'̶t̶.
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    I read point 5 as a "this time its different" sentiment which itself is a popular indicator of an approaching downturn ;)
    – Manziel
    Feb 19, 2021 at 8:02
  • "the electrification of smart grids" does not make any sense, because smart grids are -- by definition -- electric grids.
    – RonJohn
    Feb 19, 2021 at 9:56
  • Fair enough, I can rephrase the last one to be a little less snarky. My point wasn't "this time it's different", but rather "investors are excited about certain technological innovations" and that those developments aren't captured by a simple indicator like this one. The "this time is different" component comes in the form that there are multiple viable monetization methods based on the current technology advancements - some companies are in a position to capitalize, while others might fall in relevance as a result. so it's a decent time to stock pick if you're a discriminating investor Feb 19, 2021 at 21:04
  • I meant "smart grids deployed and powered for the first time" or "power grids updated to digitalized, computerized smart grids with interconnected sensing and two-way communication", but those are wordier. Feb 19, 2021 at 21:08
  • There have been many times of change before a major downturn. Think of electronics, biotech, the dotcoms. In retrospective many visions have come true but not before a downturn has weeded out the initial overvaluation. And disruption does not necessarily favor the disruptors. In Q4/2020 VW sold more EVs than Tesla. There are plenty of established companies working with hydrogen that actually turn a profit while most of the currently hyped companies will be a shadow of their former selfes in the medium distant future
    – Manziel
    Feb 19, 2021 at 22:20

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