The Avoidable Mistake Investors Make When the Stock Market Hits All-time Highs

Don't be clever, be consistent

Here’s something I overheard from two parents talking about investing in the cafe of the science center last week:

“The stock market looks too high. I’m going to wait until the next crash before investing any more money.”

Yes, I edited that sentence to be clearer for the purpose of this article, but that was the sentiment they were expressing: stocks look too high, and therefore, they should be crashing soon.

At the time I overheard that conversation, the S&P 500 was only 8% below its all-time high.

I am not the kind of person who injects themselves into conversations that I overhear, but it did inspire me to write today’s post, which is why investing when stocks look expensive is not as dangerous as many people assume it is.

The stock market is constantly setting new records—that’s how it’s supposed to be

What do you think is more likely in a year when the S&P 500 reaches an all-time high?

Option 1: a market crash takes place later in the year?

Option 2: the market sets 10 or more new all-time highs in the same year?

Your gut is likely telling you option 1 is correct because, as we’ve covered, the financial media has economic incentives to keep you in a constant state of fear.

The reality is that option 2 is correct. When the market sets an “All-time” high, it’s much more likely to keep going up than come crashing down. Have a look at this chart below, measuring how many days in a year the S&P 500 closed at a record high.

Data source: S&P Global, chart created by the author.

Here are a few facts about “new all-time highs” that put this into context.

• 6 out of 10 years since 1958 have seen multiple records in the S&P 500.

• Including years with zero new records, the market closed with a record-high 18 times per year on average.

• Excluding the years with zero new records, the market closed with a record high, an average of 29 new all-time highs per year.

Historically, in years when the market is going up, you would expect the market to set a whole lot of new records.

Okay, so the market sets a lot of new records. But the big question is, how has the market performed AFTER setting a new all-time high?

This question is important because it speaks to the narrative that by getting out of the market at an all-time high, you can outperform buy-and-hold investors who don’t time the market; they stay invested regardless of whether it looks “expensive” or “cheap.”

How does the stock market perform after setting a new all-time high?

If a new all-time high is a sign of an impending market crash, then we would expect investors who put new money in after an all-time high to lose money.

Except they don’t.

Research from JP Morgan outlines the data that definitely shuts down the narrative that you should avoid investing your money when the market hits an all-time high.

In their research, JP Morgan looked at the total S&P 500 returns from 1988 through August 2020 and found that if you had invested your money on a randomly selected day, your average return on investment after one year was 11.7%.

That’s not bad at all. I’d take a nearly 12% return any time.

But what would your average return have been if you only invested on days when the market closed at a time-high? 14.6%. You would have outperformed by nearly 2.9% if you only invested after the stock market broke a new record.

If we zoom out to a three or five-year time horizon, your cumulative returns from only investing after new all-time highs would continue outperforming.

Data Source: JP Morgan, chart created by the author

Stick to your plan

Does this mean a new all-time high means you should expect the market to keep going up indefinitely?

Of course not.

The kernel of truth that the pundits pushing the “wait for a crash” narrative exploit is that eventually, there is an all-time high that is followed by a crash or bear market. The problem is that we don’t know if that will be in one day or 10 years from now.

It’s simply more evidence that we should not time the market no matter how appealing the narrative of the day is. The lesson for long-term investors is to stick to your strategy and not get stressed about the fact that you’re investing at an all-time high.

There’s nothing easier than to be pessimistic, especially about the stock market. Optimism is hard, but in the long run, optimism is more profitable.

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This article is for informational purposes only. It should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any major financial decisions.