15

I have some money I intend to invest over the next 3-4 years. An important chunk of my portfolio would be invested in a stock market index ETF such as one representing the S&P 500. Unfortunately, the S&P 500 has hit all-time highs recently.

I wouldn't be buying a big chunk now, but investing monthly over the next 3-4 years, so if the market were to crash tomorrow (or at some point during that period) I'm reasoning it wouldn't be that bad. I've run some simulations and this strategy seems to work, but I'm unconvinced.

Under this kind of scenario, would it make sense to buy anyway?

The alternative I'm considering is buying bonds and just waiting until the next crash to buy. I'd be missing on the returns from now until the crash (that may take a loooong time to come) but I'd be getting some returns for low risk and essentially buying time. OTOH, that sounds like market timing, and everything I read is against trying to time the market (and I agree).

Any insights to break the mental knot I got myself into?

  • 6
    We don't like questions that ask whether it's the right time to buy a specific security, so I've generalized your question somewhat to use the S&P 500 as an example of any market index ETF. This way, we can avoid answers from prognosticators and fortune-tellers and look at the other factors surrounding the issue. – Chris W. Rea Sep 21 '13 at 13:25
  • Thanks for the edit. I'm sorry if the question sounded too specific, it is indeed more general as your edits reflect. – ggambett Sep 21 '13 at 13:27
  • What makes you think the bond market won't crash? If you are buying US Treasury securities as a safe bet instead of corporate or municipal bonds (think Detroit), what will happen to them if the current shenanigans in the US Congress continue without resolution past September 30? This message will be deleted by the moderators in thirty seconds.... – Dilip Sarwate Sep 21 '13 at 13:42
  • 5
    @DilipSarwate I don't see any problem with your comment, other than your point about lack of diversification might be better written up in an answer. How about a brief essay answer on portfolio construction that I can upvote, rather than a witty comment? ;) – Chris W. Rea Sep 21 '13 at 14:12
  • 1
    Quick question. You said * invest over the next 3-4 years*, but do you intended to withdraw the money at that time? If so, I would suggest you are a saver, not an investor and being in the market is too much risk. – MrChrister Sep 23 '13 at 18:53
20

Here is, from Yahoo Finance, the S&P 500 over the last ~60 years (logarithmic scale):

S&P 500 Index

The behavior since ~2000 has been weird, by historical standards. And it's very easy, looking at that graph, to say "yes! I would have made so much money had I invested in March '09!". Of course, back in March '09, it wasn't so clear that was the bottom.

But, yes, over the last 10 years or so, you could have made more money by adopting a rule that you'll accumulate cash in a FDIC (or similar) insured savings account, and dump it into an S&P index fund/ETF when the index is n% off its high.

Of course, if you look at the rest of the chart, that strategy looks a lot less promising. Start in the early 80's, and you'd have held cash until the crash in 2000.

Except for the recent weirdness, the general trend in the S&P 500 (and stock markets in general) has been upward. In other words, to a first-order approximation, the S&P 500 is always at an all-time high. That's just the general trend.

13

"In other words, to a first-order approximation, the S&P 500 is always at an all-time high."

I'm going to run with this observation a bit. The crash of '87 was remarkable. It was a drop of 1/3 in a short time, yet, when one looked at the year, the Dow was up nearly 5% with dividends included. A one-year Rip Van Winkler would have woken up thinking it an unremarkable year.

I actually recall a conversation I had on Aug 25th 1987. I was discussing the market with a colleague over lunch, and while I didn't call the top that day, I remarked that it didn't matter much, that 5-10 years later just staying in the market would have been the right thing.

enter image description here

Compare this 87-95 chart to the longer term chart derobert shows. In his chart, this is all but a blip. In my chart you can see it took about 3-1/2 years to be in the black, as the market then shot up from there. A dollar cost averager would not have bought at that short term high, well not more than a tiny bit.

The best I can do to conclude is to say I'd never just buy in all at once. You buy in over time, X% of your income each month (i.e. dollar cost averaging), and if you have a chunk to invest, smooth it out over a few years.

1

In 1929 the Dow Jones Industrial Average peaked at roughly 390 just prior to the Great Depression. It did not return to that level again until 25 years later in 1954. 25 years is a long time to go without any returns, especially if you are a retiree.

There is no easy answer with investing. Trying to time the tops and bottoms is widely regarded as a foolhardy endeavor, but whenever you invest you expose yourself to the possibility of this scenario.

The only thing I highly recommend is not to base your decision on the historical returns from 1975 to 2000 that the other answers have presented. These returns can be explained by policy changes that many are coming to understand are unsustainable. The growth of our debt, income inequality, and monetary manipulation by central banks are all reasons to be skeptical of future returns.

DJIA 1929-1954

  • So, your answer is "never buy at the very top? – JoeTaxpayer Jun 8 '16 at 23:29
  • No. :) As I said, there is no easy answer. For the reasons I presented in the last paragraph though, I would advise against investing right now. That is a larger debate though and my point was mostly to be skeptical of the returns cited by other answers. – Comptonburger Jun 9 '16 at 0:00
  • Your advice could just as easily have been given 10 and 20 years ago. And the person that did not invest would have lost out on tremendous gains. I recall the Business Week cover sometime in 1975 "The Death of Equities". Once again, someone who listened to that would have lost out on huge gains. Is it risky? Sure. But there's no reason to believe it's any more risk than it was 30 years ago. – TechnicalEmployee Jun 10 '16 at 16:14
  • @TechnicalEmployee I did not give any advice on whether or not to buy now. The closest I came to that is saying to be skeptical of the 1980-2000 returns repeating. I would not have said that 20 years ago because fundamentals were different. – Comptonburger Jun 11 '16 at 18:15
  • But using DCA from top you get 50% back in less than 8 years, so you will gain something in case you would buy regularly even from prices before crash and have enough money and faith to continue buying against falling market. – Tom Jul 5 at 11:46
0

Being long the S&P Index ETF you can expect to make money. The index itself will never "crash" because the individual stocks in it are simply removed when they begin performing badly. This is not to say that the S&P Index won't lose 80% of its value in an instant (or over a few trading sessions if circuit breakers are considered), but even in the 2008 correction, the S&P still traded far above book value.

With this in mind, you have to realize, that despite common sentiment, the indexes are hardly representative of "the market". They are just a derivative, and as you might be aware, derivatives can enable financial tricks far removed from reality. Regarding index funds, if a small group of people decide that 401k's are performing badly, then they will simply rebalance the components of the indexes with companies that are doing well. The headline will be "S&P makes ANOTHER record high today"

So although panic selling can disrupt the order book, especially during periods of illiquidity, with the current structure "the stock market" being based off of three composite indexes, can never crash, because there will always exist a company that is not exposed to broad market fluctuations and will be performing better by fundamentals and share price.

Similarly, you collect dividends from the index ETFs. You can also sell covered calls on your holdings. The CBOE has a chart through the 2008 crisis showing your theoretical profit and loss if you sold calls 2 standard deviations out of the money, at every monthly interval.

If you are going to be holding an index ETF for a long time, then you shouldn't be concerned about its share price at all, since the returns would be pretty abysmal either way, but it should suffice for hedging inflation.

  • 1
    The S&P 500 underperforms the indices that do not remove stocks. The indices that include everything do better. The Wilshire 5000 (that includes all publicly traded stocks -- over 6000) outperforms the S&P 500. – dcaswell Sep 24 '13 at 0:24
  • 3
    "The index itself will never "crash"" - What word do you use to describe that 2008 event? "the returns would be pretty abysmal either way" - any data to support this assertion? – JoeTaxpayer Sep 24 '13 at 1:12
  • Thanks for the answer. By "crash" I didn't mean "becoming worthless" as it could happen to an individual stock, but a 2008-like drop. Even if in the long term your returns are positive, I understand putting all of your money at once just before the crash would yield lower long-term returns than putting all of your money just at the minimum. – ggambett Sep 24 '13 at 5:20
  • And regarding broader indexes, I haven't found a non-US domiciled ETF (European, specifically) that tracks something broader than the S&P 500 :( – ggambett Sep 24 '13 at 5:21
  • @JoeTaxpayer The phrase I would use for the 2008 event is a "liquidity crisis", the financial sector became illiquid and overleveraged companies tanked in share price, the S&P index still traded way above book value even during that time period. People shy away from the markets during these times because they are not sure where the bottom is, but given the formula used to created the S&P index, the point is that it will never become worthless. There were companies that did pretty well during that time... netflix, apple... – CQM Sep 24 '13 at 14:32
0

The simple answer is:

  • if you think that the price will raise, then "yes, it makes perfectly sense".

Where 'think' stands for "after your calculations, and guts/intuitions, and analysis", of course.

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.