It seems that every time the stock market reaches an all-time high there’s some investing guru warning that the market is at its top and a bear market will soon follow. Of course, bear markets do happen. But they’re very difficult to predict. If you’re worried about investing when the market is at record highs, it can be helpful to have some perspective.
First off, since 1928, about one out of every 20 trading days has closed at an all-time high. So, new highs aren’t that unusual. From 1926 to 2018, large company stocks have returned an average of about 10% per year. This means stocks have moved higher over time. As you can see, the uptrend is made up of higher highs and higher lows. So, when you see record highs should you worry about buying too late or that a crash is imminent?
If you’re a long-term investor, try to keep a long-term perspective. Let’s say you had the worst luck in the world, and you invested in a basket of stocks tracking the S&P 500 Index at the peaks just before major bear markets hit, like August 1987, March 2000, or October 2007. No matter which peak you entered at, as of November 2019, your return would still be positive if you’d stayed invested.
In fact, you’d be up about 921%, 101%, or 98% respectively. While the ride may have been rough, you’d be all right if you hung on through the highs and lows. This is a simplified fictional example that assumes a risky 100% allocation to stocks, but it shows that timing the market shouldn’t be a major concern for long-term investors.
However, this doesn’t mean you can just ignore your portfolio. All-time highs are a good opportunity to examine and manage your risk. All investors should consider rebalancing their portfolios, and active investors may consider hedging. Let’s take a look at both. While a bull market may be great for portfolio growth, it may throw off your asset allocation.
Rebalancing, which means selling some of one asset class and adding the funds to another, can help you manage risk in your portfolio. In this case, you’d sell some of your stocks and buy more bonds. If you think about it, this is the most basic investing strategy selling high and buying low. Keeping your target asset allocation can mean you have less risk if the market falls, but you’re still invested if the market rallies.
Even though market tops are difficult to predict, some investors may want additional portfolio protection. If you’re an active investor who’s concerned the market may turn bearish, you might want to consider hedging, which can help provide protection for your portfolio. If stocks in your portfolio decrease in value, a hedge is designed to help increase in value, potentially offsetting some of the losses.
A common form of protection is buying put options. If stocks lose their value, their put options generally increase in value. If stocks go up, the puts expire worthless and the amount invested in them is lost. Puts are generally less expensive when the market hits all-time highs because low demand results in lower implied volatility and lower premiums.
As you can see, all-time highs don’t mean you need to avoid investing, especially if you have long-term investing goals. Just don’t forget to manage the risk in your portfolio.