Investing Today?
Thoughts on Putting Money To Work In Today’s Market
Lately I’ve been asked by some people, mainly younger investors, about putting money to work. Well, that’s a very interesting question because we live in interesting times. With the stock market at all-time highs, and interest rates near all time lows (meaning bond prices are very high because of their inverse relationship), you might be tempted to think it’s a bad time to invest. Certainly, I would be very hesitant about putting much money to work in bonds. With interest rates having nowhere to go but up, one is getting paid very little yield to assume the risk of capital losses on bonds. And if you are a long-term investor, one with a 5+ year time horizon, you probably want most of your long-term investment in equities.
How do we know the stock market is high? One of the best valuation indicators is the CAPE Ratio (Cyclically Adjusted Price to Earnings Ratio) developed by Nobel Prize winning economist Robert Shiller—one of the few economists I trust. This measure looks back 10 years and smooths out the stock market’s price to earnings ratio—a measure of stock prices. Currently, that ratio stands at 36.6 with the highest reading of 44.19 recorded in December, 1999 during the internet bubble. Its historical average is about 17. Thus, stock prices are quite high. Here is a chart of the CAPE ratio in blue and long-term interest rates in red.
The chart says it all. So, what is an investor to do? First, there is always something to worry about. If one were to wait until the investing future is “clear” one would never put money to work. Second, I have no idea what the markets will do over the next few years and neither does anyone else. What we can say it that when markets are historically high, the expected future returns are lower and vice versa. Here is a chart that shows the negative relationship between price and future 10-year returns.
Based on this chart, with a CAPE ratio of 36, we can expect about a 2-3% annual return over the next 10 years in the S&P 500. Of course, actual returns could be better, or worse. This chart is important because investors are often told that, historically, equities have returned 8-10%, and as a result that historical past return of 8-10% becomes an expected future return. This may not be the case as the chart above suggests.
Getting back to the original question of what to do with our money, I suggest investors that may be starting their investing lives, or those with a large lump sum to invest, put relatively small amounts to work, say, monthly. In other words, dollar cost average into the market rather than risk the whole sum at once. For instance, an investor with $12,000 to invest may want to buy $1,000 of securities every month. Because all your money isn’t at risk right away, you may very well sleep better. That said, you may want to kick yourself if the stock market rises quickly to greater heights, however, losing money hurts a great deal more than missing out on gains. Trust me, I know. The bottom line is no one really knows the future, and investing is all about the future. A measured approach to adding money to the market, in these times, seems like a smart way to go.
I began investing in early 1987. In the fall of ’87 came the stock market crash know as Black Monday. On that day the market dropped 22% —the largest one-day loss in history. Since then, there have been many ups and downs, crises, as well as good times. America always seems to get better, albeit it fits and starts. I have no reason to believe that will change.
Onward,
Pat Brennan
Pat Brennan is the founder of bucksandparks.com.
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