The US stock market has been tearing up this year, registering new all-time highs many times.
Would it be a good idea to invest in a broad market index such as the S&P500 when it is at an all-time high?
Let’s Look at Some Scenarios
Let’s consider a practical scenario. Imagine an investor receiving $2,000 at the start of each calendar year. They can invest this amount at any point during the year.
Consider five investors with different investing approaches:
- Mr. Perfect: Somehow, he can invest at the lowest closing point every year (always buying the low every year). Yeah, we know it’s impossible, but just for the sake of our illustration, let’s assume this is possible.
- Mr. Worst: The opposite of Mr. Perfect. Somehow, he constantly invests at the highest closing point every year (always buying the top every year). Talking about poor luck 🙂
- Mr. Lump Sum: He doesn’t care about market movement and invests the whole $2,000 on the first trading day of the year.
- Mr. DCA: He also doesn’t care about market movement. He splits the $2,000 into 12 equal amounts and invests each on the first day of the month.
- Mr. T-Bills: He always fears market movement and continues believing a better entry point will come. But he never puts money into the market; he keeps it invested in T-bills.
The Result After 20 Years
Who do you think will have the highest amount after 20 years?
In this illustration, we use the data for the S&P500 index from 2003-2022.
Unsurprisingly, Mr. Perfect has the highest amount after 20 years. But as we mentioned earlier, this is almost impossible to achieve because nobody’s perfect 🙂
Instead, let’s look into the more realistic investors: Mr. Lump Sum and Mr. DCA.
Mr. Lump Sum slightly outperforms Mr. DCA. The market is more bullish than bearish most of the time, so the more time you are in the market, the higher the likelihood you can perform better.
And here is the exciting bit: Mr. Worst, which is also nearly impossible unless you have super bad luck, only performs about 10% worse than Mr. DCA!
Even if you are unlucky and keep buying the top, you will likely do well over time.
Now comes Mr. T-bills, with the lowest amount after 20 years. And the difference is significant! Even Mr. Worst has 155% more than Mr. T-bills.
What can we learn?
Focus on the time in the market, not timing the market. Don’t let market emotion paralyze you and be like Mr. T-bills.
Summary
If you want to avoid getting too involved with the market, investing in an ETF tracking broad-based index can be a good option. But, more importantly, stay consistently invested in the market.
Either be Mr. Lump Sum or Mr. DCA, and there is a good chance you will be fine over the long term.
For more sophisticated investors, you can also perform some fundamental and technical analysis to assess whether the market is overpriced or overbought in the short term, amplifying your return further.
Happy investing 🙂
