If you have cash to invest, you might also have a lot of questions that you want to get clarity on before you make any money moves.
Investing can get complex, and fast — and not everyone has the time or desire to dig into the research or sift through the noise in order to find the signal they really need.
To help you get traction, we’re addressing 3 common questions around the market and investing that we’ve heard lately.
Here are the answers you may need to know:
I Have Cash to Invest — When Should I Put It in the Market?
Have cash to invest but don’t want to risk putting it in the market right before a downturn?
You’re not alone. Many folks still feel wary about throwing their cash to invest into the market, especially when recession fears are running high.
The lure of getting in at the right time or avoiding the next downturn is really tempting, even if you’re a disciplined, long-term investor.
The reality of successfully timing markets, however, isn’t as straightforward as it sounds.
The math says getting your cash to invest working for you ASAP almost always provides a better outcome than hanging back.
(If you feel really uncomfortable with the idea of putting a lot of money in the market all at once, a possible solution is to put it in an extremely conservative portfolio; research also suggests that’s better than leaving it in cash.)
We also know that attempting to buy individual stocks or make tactical asset allocation changes at exactly the “right” time is virtually impossible, because markets are fiercely competitive and adept at processing information.
During 2018, a daily average of $462.8 billion in equity trading took place around the world. With that kind of volume, available information, from economic data to investor preferences and so on, is quickly incorporated into market prices.
If you think you can time the market based on an article from this morning’s newspaper or a segment from financial television or that “hot tip” from your brother-in-law, know that any info you get is already reflected in prices before you get a chance to react to it.
To be clear, this isn’t because you’re not capable or smart enough; even professional investors have difficulty beating the market.
Yes, favorable timing is theoretically possible. But the problem is, there just isn’t much evidence showing that it can be done reliably, and consistently over long periods of time (which is most of us are investing for), even by professional investors.
The good news? You don’t need to time markets to have a good investment experience.
Over time, capital markets have rewarded investors who have taken a long-term perspective and remained disciplined in the face of short-term noise.
By focusing on the things you can control (like having an appropriate asset allocation, diversification, and managing expenses, turnover, and taxes) you can better position yourself to make the most of what capital markets have to offer.
Are Index Funds Too Popular?
Over the last several years, index funds have received increased attention from investors and the financial media. Because of this rise in popularity, some commentators claim the result is distorted market prices.
But is that true? The data and evidence we have suggests otherwise, and continues to support a passive investment strategy (versus active management, like stock picking and market timing) as the most reliable way to go for long-term investors looking to grow wealth.
Index fund investors still make up a relatively small percentage of total market participants. Data from the Investment Company Institute shows that as of December 2017, only 35% of total net assets in US mutual funds and ETFs were held by index funds.
Not to mention, tools like ETFs are often used by active managers who buy and sell them frequently. They’re included in that 35% number — but they don’t behave as passive investors at all.
Even though the empirical evidence suggests that the rise of indexing is unlikely to distort market prices, let’s just pretend for a moment that the popularity of index funds does distort markets.
In this scenario, we would expect stock-picking managers attempting to capture mispricing to have an increased rate of success over time. There is little evidence that this has been the case.
We’d also expect to see more uniformity in the returns for securities within the same index as inflows drive prices up uniformly (and outflows drive prices down) if the popularity of indexing was causing something like a bubble.
Taking the S&P 500 Index as an example, however, it’s obvious this isn’t the case.
In 2008 — a year of large net outflows and an index return of –37% — the constituent returns ranged from 39% to –97%.
In 2017 — a year of large net inflows and a positive index return of 21.8% — the constituent returns ranged from 133.7% to –50.3%.
This isn’t a reflection of what we’d expect to see if index funds were truly “too popular” to the point where they distorted an efficient market.
The bottom line is the data continue to support the idea that markets are working:
- Annual trading volume continues to be in line with prior years, indicating that market participant transactions are still driving price discovery.
- The majority of active mutual fund managers continue to underperform, suggesting that the rise of indexing has not made it easier to outguess market prices.
- Prices and returns of individual holdings within indices are not moving in lockstep with asset flows into index funds.
Yes, index funds are more popular — but that doesn’t mean passive investment strategies need to be thrown out the window.
If the Average Stock Market Return Is 10%, Why Doesn’t My Performance Look Like That?
The US stock market has delivered an average annual return of around 10% since 1926.
You’ve probably heard something like this before — which might not jive with what you see when you look at the market on any given day. So what gives?
The short answer is, short-term results may vary. Stock returns can be positive, negative, or flat in any given time period.
However, we can reasonably assume that, over the long-term, the market will trend upward and increase in value over time.
When it comes to knowing what to expect from your own portfolio, it might be helpful to see the range of outcomes experienced by investors on a historical basis.
For example, how often have the stock market’s annual returns actually aligned with its long-term average?
If you looked at the calendar year returns for the S&P 500 Index since 1926, you’d see that the S&P only had an annual return of plus or minus 2 percentage points from 10% 6 out of the past 93 calendar years.
Most years, the index’s return is outside of the range, often above or below by a wide margin. And more importantly, there’s no obvious pattern for this.
This should highlight the importance of looking beyond average returns and being aware of the range of potential outcomes.
Despite year-to-year volatility, we know we have a chance at improving our chances for a positive outcome by maintaining a long-term focus.
Positive performance is never assured — but it’s clear to see that your odds as an investor improve when you invest over longer time horizons.
It’s always easy to stay the course in years that experience above-average returns. And yes, periods of disappointing results will likely test your faith in equity markets.
But being aware of the range of potential outcomes can help you remain disciplined. That discipline and commitment to a sound investment strategy over time can increase the odds of a successful investment experience.
Understanding how markets work and trusting market prices are good starting points for keeping cool during emotional or turbulent times. Setting up an asset allocation that aligns with personal risk tolerances and investment goals is also a smart step.
By thoughtfully considering these and other issues, you give yourself a chance to better prepare to stay focused on your long-term goals during different market environments when things might look anything but “average.”
Want more financial advice you can actually use? Check out Beyond Your Hammock, a fee-only financial planning firm that specializes in helping 30- and 40-somethings get clarity and start building wealth.