Many of our clients hold too much cash even though it’s no secret that investing that money is likely to earn a much better return over the long term. In fact, sitting in cash often generates a negative return after adjusting for inflation.
We know there are lots of reasons why people hold onto too much cash, but some of them are more rational than others. It’s smart to hold cash for a short-term goal like an upcoming home purchase because you don’t want to take market risk on your big down payment, and it’s a good idea to have a rainy-day fund. But as we will explain, it’s not a good idea to hold cash because you’ve heard the market might be at an all time high.
“Buy low, sell high” is easier said than done
You’ve probably heard the common investing advice to “buy low, sell high,” meaning you should purchase stocks when the price is down (and they’re “on sale”), then sell them when they are at peak price. That’s good advice that will generate a very high return if you can consistently determine the right time to buy and sell. The unfortunate reality is that it’s almost impossible to do consistently. Less than 10% of professional investors like mutual fund and hedge fund managers outperform the market after five years. But that doesn’t mean you shouldn’t invest in the stock market. It just means you should buy index funds rather than trying to outperform the market by picking stocks. As we have pointed out in the past, investing successfully has nothing to do with timing the market.
It doesn’t matter that the market is at an “all-time high”
Even if you don’t consider yourself a market timer, your friends and the media might be telling you that the market is at an all-time high right now. Therefore it must be a terrible time to invest, right? Wrong!
This is a trap you don’t want to fall into. If you’re tempted to defer investing for this reason, here’s what you should do:
- Look at the last time the market was at an all-time high. On average, this has happened roughly 1 in every 14 market days since 1950. If you had taken the advice to not invest the last time the market was at an all-time high, it’s likely you would have missed the current all-time high. Of course there are bull and bear markets (extended periods of very positive and very negative trends), but the beginning and end of these trends are impossible to predict.
- Think longer-term. Since 1950, the S&P 500 closed the year higher than it closed the previous year 72% of the time (you can see this upward trend in the chart below). If you look at five-year time periods instead, that number is close to 80%.
To demonstrate the magnitude of what you might lose by not investing when the market is at an all-time high, let’s look at an example. Let’s assume you were considering investing $10,000 in the S&P 500 on January 26, 2018 but felt too nervous to do so because the market was at all all-time high. As you can see from the chart below, the market hit many more all-time highs in the next 2 years — 47, to be exact. In this situation, your reluctance to invest would have cost you $1,602 before taxes over that period of time. Trying to time the market can prove very expensive.
The best strategy is buy & hold a diversified portfolio
Instead of obsessing over daily fluctuations in the S&P 500, you should buy a diversified portfolio. The beauty of buying a diversified portfolio that holds relatively non-correlated asset classes is that it should always increase in value over the long term, because when some asset classes are down, others will be up.
If you’re worried about the regret you might feel if you invest now (at a “market high”) and the market plunges in the short term, we recommend checking out our blog post on dollar-cost averaging. Setting up a small recurring deposit to spread your investment out over time might help ease that fear.
The U.S. stock market may be at or near an all-time high, but that shouldn’t affect your decision to invest at all. The S&P 500 has hit many all-time highs before, and there’s every reason to believe it will continue to do so. The advice to “buy low and sell high” is virtually impossible to follow (even for professional investors!) and you shouldn’t bother trying. You’re far more likely to come out ahead if you put your money into a diversified portfolio and leave it there.
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About the author(s)
Kara Brenholt, CFA, is a Product Manager at Wealthfront. She joined Wealthfront's Client Services team in 2015, and graduated from NYU in 2014 with a B.S. in Finance and Marketing. View all posts by Kara Brenholt