Beat the Fear of Investing at Record Highs
For the next six weeks our advisors will explore different aspects of investor behavior and the effect it can have on a portfolio. First, I want to concentrate on investment time frames, and how a timeline might be the best guard against irrational fears of investing at a “top”.
Take a glimpse at the market over the past few weeks and there’s no indication that our country is still grappling with the “Great Recession”. The stock market is in record territory (as measured by the Dow Jones Industrial Average and the Standard and Poor’s 500) and recent gains propelled these indexes to their highest levels since 2007.
It almost seems too good to be true. As a result, investor behavior is usually one of caution and concern. They wonder, is now is a good time to enter the market, just as it reaches record highs?
When volatility comes or when new highs are reached, many investors shift from a focus on the distant horizon (their long-term goals) to a short-term focus, almost as if they may spend their retirement funds tomorrow! All too often this behavior can be disruptive to long-term results.
It’s important to keep a long-term perspective no matter the situation. History has shown us that a 5-10 year investment in equities (stocks) represented by the DJIA or the S&P 500 has had a positive return using 5-year rolling averages for the past 20 years, but only if investors don’t try to time the market.
- Over the last 20 years, the DJIA had a positive return over 5-year rolling periods 95% of the time.1
- Historically the dividends paid by companies are a large contributor to the total return of the stock market. In fact over 40% of the long-term total return of the S&P 500 comes from dividends!2 Put your money on the sidelines and it’s more likely to collect dust than dividends.
- A recent survey by financial research firm Dalbar determined that over 20 years ending December 31, 2009, the average stock investor’s return trailed that of the broader market by nearly 5% per year as measured by the S&P 500. Put another way, if the market gained 10% annually, the average investor’s portfolio realized only a 5% yearly gain. Much of this differential stems from investors who sold near the bottom of the market and missed some of the market’s best days while sitting on the sidelines.
- (Obviously no strategy can assure a profit or protect you from a loss, and an investment in securities involves risk such as loss of principal.)
But it all comes down to a simple idea; those who try to “time” the market usually fail. Those who remain committed to a long-term strategy often fair better.
The correct behavior is just as simple. Set your own time horizon and plan for that. Market turnarounds often happen suddenly and unpredictably; being on the sidelines when a reversal occurs can rob investors of significant return potential over longer periods.3
Always remember to consider the time-frame for any investment and stay focused on your time frame, not market records or squiggles. The hardest part of being an investor is resisting the urge to react emotionally when volatility comes or new stock market highs appear. In the end, this year’s high could be next year’s low.
Securities and Advisory Services offered through LPL Financial. Member FINRA/SIPC.
Morningstar hypothetical performance of rolling 5 year monthly total return of the Dow Jones Industrial Average.
Seeking Alpha, May 22, 2012 article “The Dividend Investor’s Guide to Successful Investing”.
American Funds – “Staying the Course” article 2012.