On 24 February the British FTSE 100 index surpassed its 1999 high. Major indices in the US, including the S&P 500 and the Dow Jones Industrial Average, are also at all-time highs. Even the NASDAQ is approaching its tech bubble record high, probably the last big psychological milestone to clear during the impressive rally that started in 2009.
Have stocks become too expensive?
If you have been smart (or lucky) and participated in the rally, should you sell now and wait for a pullback to get back in? If you have new cash to invest, should you buy stocks now, at record high prices, or wait to get a discount? If you buy stocks regularly every month as part of your ISA or pension plan, should you stop and wait for a correction?
To find an answer to the questions above, first ask yourself the following:
Why do you invest?
For most people the answer is to grow wealth and save for retirement. In other words, most people’s time horizon is very long. If you are in your 40’s, you have at least 15 or 20 years until you start to consider drawing regular income from your investments.
Stocks have historically outperformed bonds and cash in the long run. Therefore, they should be part of your portfolio, unless you are already close to retirement age (in such case it makes sense to keep a greater share of your savings in less risky investments).
Any decision about buying or selling stocks must always be made in the context of your long-term financial plan, based on your time horizon, personal circumstances, risk attitude, needs and objectives. Your stock investments should never be considered in isolation, but together with all your other financial arrangements, including pension plans, insurance and real estate. Because future direction of stock prices is impossible to predict, the current level of stock indices and your feelings about the market should never override your long-term investment strategy.
But wait… What if it’s like 2007 and the stock market will crash? There are so many possible reasons: the Fed, Greece, Ukraine or ISIL, to name just a few.
Imagine it is 2007. Stock indices are close to their all-time highs. The economy and corporate profits look solid. The Fed stopped hiking interest rates last year. One pound buys more than two dollars. You have read two articles about subprime mortgages and exotic derivatives, but haven’t paid attention, because no one has. Because you are saving for retirement and your time horizon is more than 15-20 years, you conclude that the best decision is to stick with your long-term strategy and buy stocks.
One and half years later half of your money is gone. With the biggest financial crisis since the Great Depression, the worst case scenario has just materialized. What do you do next? Because your time horizon is long, you stick with your long-term strategy and stay invested. Buy more stocks if you have extra cash. Several years later in 2015, stock indices are at all-time highs and so is your retirement portfolio.
If you invest in stocks, you must be willing to accept volatility. If you stay consistent and won’t panic, you will be rewarded by higher returns in the long run. It is not really important what the stock market will do next year.
Let’s conclude with a popular piece of investing wisdom, a quote usually attributed to Sir John Templeton:
“The best time to invest is when you have money. This is because history suggests it is not timing the markets that matters, it is time.”