As I sit here typing this afternoon the S&P 500 is trading at 1670, up 14% since the beginning of the year. 27% over the last 12 months. The very definition of a raging Bull Market. Add to this the fact that it has more than doubled since the Spring of 2009.
Whether you are considering investing a new chunk of cash that has come your way or whether to sell and sit on the sidelines for a while, it is times like these that test your core investing principles and beliefs.
Here are some of mine:
- It is impossible to time the market, regardless of all the heavily credentialed gurus on CNBC and the like who claim they can.
- The market is the most powerful wealth-building tool of all time.
- The market always goes up, but it is always a wild and rocky ride on the way.
- Since we can’t predict these swings, we need to toughen up mentally and ride them out.
- I want my money working as hard as possible, as soon as possible.
But for novice investors, it is impossible not to look at the past market swings and think, “If only!”
jlcollinsnh reader Wendy was kind enough to write and ask precisely these questions and express precisely these concerns. Since my guess is that lots of readers are wrestling with the same, for today’s post let’s look at her note and explore it together.
Hi James,
I’ve recently inherited a chunk of money from my dad and knew it was important to start investing. I’m very new to this as I haven’t invested in stocks, bonds, or anything before. I have been researching about investing and stumbled upon Mr. Money Mustache and in turn you.
I’ve learned a lot about what to do before a stock market crash if you’re ALREADY investing, but my big question is…
If I’m am going to start investing for the very first time, is NOW a good time, right before a possible stock market crash?
I have read about us being in a boom and a lot of people seem to think a stock market crash is just around the corner. I know there’s always going to be ups and downs in the market, but I’d like to get off to a good start by growing $60k and contributing about $1000+ per month.
What I fear is that I’m entering at the wrong time. That I’m investing right before a stock market crash and my $60k won’t earn much over a short period. Then, suddenly a crash will happen and I’ll be down to $20k, and then growing from there. I’d rather grow from $60k, than $20k.
My fear had held me off for months, but I feel because I’m holding off I’m losing out. I just want to get off to a good start, not a bad one.
After reading Mr. Money Mustache’s last posting, I thought I should be investing, just more bonds less stocks. So I decided I want to go for a 70/30 portfolio being I’m 30 and with Vanguard as you and MMM have recommended. So last night I opened a VBTLX and put $42k into it and was just going to hold off on stocks and put the stock money into my 1% high-yield savings til after the crash. This morning though I’m having doubts that I jumped in too early and should have waited til after the crash because I still may lose a chunk of money.
If I am doing things right in getting started, should I also be putting that 30% into stocks now too or just hold off til after a crash so I can make the most of that money?
I’m just so fearful since I’m so new to this. Any advice on what steps I should take or change would be greatly appreciated. Thank you in advance for taking the time to look into my situation.
Sincerely,
Wendy
PS: I’m not wanting to retire at 60. I don’t really have a deadline, I’d just like to retire as soon as I can, but with enough money to enjoy traveling and just work for fun here and there where it’s optional. I’m not sure with my income and savings if that will even be possible, but I’d like to try. So that’s why I want to be smart about how I get started.
Hi Wendy…
Welcome and thanks for the great and timely questions!
We’ll start with your comment, “I’ve learned a lot about what to do before a stock market crash if you’re ALREADY investing…”
It doesn’t matter if you have 60k in cash waiting to invest or if you already have the 60k invested, your concerns and fears regarding a market crash will be the same. So, step one will be to learn to deal with your fear.
Fear is the major theme of your note. Don’t feel bad. It is one of the two major emotions that drive investors, the other being Greed.
Fear is perfectly understandable. Nobody wants to lose money. But, until you master it, fear will be deadly to your wealth. Once you are invested it will cause you to flee in panic for the exits every time the market drops. And drop, repeatedly on it’s relentless march up, it will. The curse of fear is it will drive you to sell in panic when you should be holding. Here’s how you deal with it:
The market is volatile. Crashes, pull backs and corrections are all absolutely normal. None are the end of the world. None are even the end of the market’s relentless rise. They are all, each and every one, expected parts of the process.
As that post says, there is a major market crash coming, and another after that. Over the decades you’ll be investing, countless smaller corrections and pull-backs as well. Learning to live with this reality is critical to successful investing over the long-term. And successful investing is by definition, long-term. Anything short-term is by definition savings or speculation.
So, if as that post claims we know a crash is coming, why not wait to invest or if currently invested sell, wait till the fall and then go back in? Simply because we don’t know when. Nobody does.
In your note you say, “I have read about us being in a boom and a lot of people seem to think a stock market crash is just around the corner.”
That’s certainly true, but there are also lots of people who say we are just at the beginning of this boom and we will never see the S&P as low as 1670 again. Every day heavily credentialed experts are predicting a market crash. At the same time, equally credentialed experts are predicting a boom. Who’s right? Beats me. Both are predicting the future and nobody can do that reliably.
So why all the predictions? Simply because booms and busts are exciting! Get it right and your reputation is made! Predicting them equals ratings. Especially if the predictions are extreme. Predict the Dow soaring to 25,000 or crashing to 5,000 and people perk up. There is big money to be made doing this, for the gurus and cable TV shows anyway.
But for serious investors, it is all useless and distracting noise. Unless you pay attention. Then it is positively dangerous to your wealth. And sanity.
History can help, but only on the broadest of scales. You see it in that chart above. The stock market always goes up. There are powerful reasons why. Click on that link you’ll find my post that discusses them and why I can say, with almost absolute certainty, that 20 years out the market will be higher than today. Why with a very high degree of confidence I’d say that 10 years out it will also be higher. Why even 5 years out my bet would be the same.
But this says nothing as to what the next few days, weeks, months or even years will bring.
Here’s the problem. There is simply no way to know where in time we are.
Look again at that chart. Could we be at a moment similar to January 2000 when the market peaked and went on to lose almost half it’s value? Or July 2007 when it did the same? Sure, it is easy to see that pattern.
Or could that pattern have run its course, and now is more like the time the market passed 1000 or 2000 or 3000 or 4000 or 5000? Each level left in the dust not to be seen again. Times when people were every bit as convinced that it was too high and ready for a crash.
Beats me.
But let’s as a mental experiment assume we do know that right now, at 1670, the market is at a top and about to crash.
Maybe a magic genie has told us so.
Clearly we’ll sell (or not buy). But now what? We want the gains only the market can deliver. So we want back in at some point. But when? Is this a 10% pull back? If so, we’ll want to buy at 1500 or so.
But what if it’s a 20% decline, the official definition of a bear market? Then we don’t want to buy until around 1330.
But what if we do that and it turns out this is a Crash!! Damn! Should have waited until 835 or so. Where’s that pesky genie when we really need him?!
The point is, to play this market timing game well even once, you need to be right twice: First you gotta call the high. Then you gotta call the low. The world is filled with sad investors who got the first right and then sat on the sidelines while the market recovered and marched right on past it’s old high.
Market timing is an un-winable game over time. How can I be so sure?
Simple:
The person who could do this would be far richer than Warren Buffett
and twice as lionized.
Nothing, and I mean nothing, would be more profitable than this ability. That’s what makes it so seductive. That’s why gurus constantly claim they can do it, even if only a tiny bit. Nobody can. Not really. Not in any consistently useful way. Believing in Santa Claus is more profitable.
Breeding unicorns is more likely.
But I don’t care. Here’s what I’d care about.
You mention that you are 30 years old. You have some 60 or 70 investing years ahead. I’d look at that chart and note that 60 years ago, around 1953, the Dow was trading at 250. Today it is 15,424. That’s thru 60 years of financial disasters, just like the ones sure to come during the next 60 years.
Or just consider the last 20 years and the S&P 500 index. In April 1993 it was around 450. Today, 1670. And that includes 2000-2009, one of the all time worst stretches in market history and a crash second only to the Great Depression.
It is in this the magic lies. The stock market’s wealth building power over time is nothing short of breathtaking.
But so is the ride along the way. Whether you invest today and it happens tomorrow, or sometime in the future, I can also guarantee you that your wealth will be cut in half more than once over those 60 years. You’ll suffer many more smaller setbacks as well. It is never fun but it is the process, and the price you and everybody else must pay to enjoy the benefits.
So really, the question you are asking is not “Should I invest in stocks now?” Rather it is, should you invest in stocks at all?
Until you can come to terms with the harsh facts above, the answer is no. Until you can be absolutely certain you can watch your wealth get cut in half and still stay the course, the answer is no. Until you read this complete stock series and understand and are comfortable with the risks that come with the rewards you seek, the answer is no.
In the end, only you can decide.
But, fortunately, investing doesn’t have to be an all or nothing proposition. If you are willing to give up some performance, there are ways to smooth out the ride a bit. It is done with asset allocation.
I describe mine here and again here. In keeping with the premise of this blog, it is the soul of simplicity. Just two funds and some cash on hand:
75% Stocks. VTSAX (Vanguard Total Stock Market Index Fund) Our core holding for all the reasons we’ve discussed.
Stocks are the Ying to our Bonds’ Yang.
20% Bonds. VBTLX (Vanguard Total Bond Market Index Fund) Bonds provide income, tend to smooth out the rough ride of stocks and are a deflation hedge. But during times of inflation and/or rising interest rates they get hammered.
5% Cash. Cash is always good to have in hand. Cash is also king during times of deflation. The more prices drop, the more your cash can buy. But idle cash doesn’t have much earning potential and when prices rise (inflation) its value steadily erodes.
Now, since you indicated you plan to hold a large percent in bonds, let’s talk a bit more about those.
Typically, the “safer” you want your portfolio to be the greater the percentage of bonds you would hold. My guess is this is why you are thinking of having 70% of yours in them.
But bonds are not without risk. In fact, of the investments I hold the one that I view as most risky right now is the bond fund. To fully understand why, you need to understand bonds a bit. Reading Part VII will help.
But basically the reason is that bond yields are at record lows. Getting there has given them a great run. But from here it is far more likely rates will rise than fall. When that happens, bond prices will drop. Rate increases could happen fast and hard. If it does, bond prices will fall fast and hard too.
Holding you bonds in VBTLX will help. The fund holds multiple bonds across multiple maturities. That will cushion the blow and it is why this is the bond fund I recommend. But make no mistake, it will still take a hit.
So knowing that, why do I still hold them? For the same reason I hold stocks knowing that a crash will come again — I can’t know the “when,” but meanwhile they provide the benefits described above.
If you want to hold 70% bonds, as you indicated, be aware of the risks that entails.
If by now you are tearing at your hair and screaming, “Fine, I’ll just put the cash in my mattress!” (Or bank account paying virtually nothing in interest), more bad news. Doing so will, short of a deflationary depression, almost assuredly guarantee a loss. (Cash is great to have in depressions) In 20 years inflation will have seriously eroded the buying power of your 60k even if the face amount remains the same.
Mmm. Remember the 20 years spanning 1993 until today? The one with all the disasters, crashes and wars? The one that took the market from 450 to 1670?
The point is: There is no such thing as a risk free investment. Having money means having risk. You only get to choose what kind.
What kind should you choose? Well now, that depends on your time horizon and goals. Let’s look at yours:
“I’d just like to retire as soon as I can, but with enough money to enjoy traveling and just work for fun here and there where it’s optional. I’m not sure with my income and savings if that will even be possible, but I’d like to try.”
That’s a wonderful goal and in fact closely mirrors my own when I first started. If you are serious and are willing to pay the price in nail-biting sleepless nights along the way, here (finally!) is my specific advice:
- Read the Stock Series on this blog.
- Read it again.
- Once you are absolutely clear on the wild ride stock investing entails, decide if you have the stomach for it.
- If, and only if, you are absolutely certain you can master your fear and will ride out the plunges and not panic….
- Put your 60k into VTSAX.
- Or into VBIAX. This holds 60% stocks and 40% bonds for a less gut wrenching ride. But you’ll still have to hang on and not sell in a panic.
- Add to this every month the $1000+ you indicated you are able to. More if you can.
- Completely forget about the market’s ups and downs.
- Or celebrate the downs as the buying opportunities they are for your monthly investments.
- When this grows to 25-times your annual expenses, you have reached Financial Independence. (This is the same as being able to live off 4% of your total stash)
- At this point, shift some of your assets to Bonds (unless of course you already have them in VBIAX). This will smooth the ride even as it lowers your performance. A trade you now want to make.
- Start living on this 4%.
- Now you can consider whether you want to continue working.
- If you keep working, while living on your 4% pour 100% of your pay into your investments. This will help dramatically expand your net worth.
- Along with it, the dollar amount 4% represents will also grow.
- With this dollar expansion of your 4%, feel free to expand your life style.
Oh, and keep us posted on your progress!
Sincerely,
jlcollinsnh
Addendum I:
OK. Having read this post you know market timing is a fool’s errand and short-term market predictions are pure silliness. Right?
That doesn’t mean they are not fun. With the full understanding that any accuracy on my part (or anybody else’s) is pure luck, here’s my call for 2013 and those of a few others in the comments.
And here’s a review of how my 2013 predictions turned out and those for 2014.
And here’s how those 2014 predictions turned out and my new ones for 2015.
Addendum II:
You can also take solace in the fact you can be the worst market timer ever and still make money. (Thanks to Elephant Eater who in this comment provided this link)
Addendum III:
In referencing the market’s performance in this post, you may have noticed I jump between using the Dow and the S&P as the indexes. I prefer the S&P because it is broader and therefore a bit more precise. But the Dow goes back further in history and is more useful (and what is available) for the long view. If you overlay their charts over time, they track together with remarkable consistency, making them for our purposes, indistinguishable.
Addendum IV:
Can market valuations predict the next crash? In short, no.
Addendum V:
It is now 2018. Wondering if it is time for me to update this post? No need. The Wealthy Accountant already has:
Where to invest your money when the stock market is overpriced
