It’s a classic investor dilemma. You’re holding cash that you’d like to invest. But the market is at or near an all-time high. You don’t want to buy at the top – no one does – but how long should you wait before investing the cash?
You shouldn’t wait at all.
Cash is not an investment since it degrades daily due to inflation. In our persistent zero interest rate environment cash is especially punished today. Holding some cash for imminent expenses, like a wedding or a house down payment, makes sense, but otherwise cash is a guaranteed loser to inflation.
If you had a crystal ball
What you want to do, of course, is invest in stocks – the ultimate growth vehicle since the dawn of capitalism – when the market is low, and sell at the top. You would definitely prefer to be out of the market when a 2008-ish plunge kicks in, right?
Sounds like a great plan. But this wait-and-pounce strategy, called market timing, only works if you can systematically predict the future. And no one can.
No one can say with certainty where markets will go next. What feels like a top is often just a stepping stone to another new high. The perilous dip that seems imminent may never materialize. Holding cash in steadily rising market (the market that’s advanced the Dow from 3,000 to 15,000+ since 1991) means that you fall farther and farther behind the market portfolio. To catch up, you’d need to take on more risk and hope for big returns over an extended period.
In my experience, investors who wait for that “big crash” to invest their cash (at bargain basement prices) rarely get the outcome they expect. As a money manager for more than 30 years and through 5 crashes, I’ve never seen anyone actually correctly time a bottom. Human nature and outright fear make it almost impossible.
So what’s a cash-holder to do? I recommend a patient and disciplined approach to get out of cash and into a diversified portfolio of low cost index ETFs. Instead of investing the full balance all at once, invest an equal amount each month over a long enough period to experience a range of prices. I often suggest 17 months, long enough to cover almost any peak to trough cycle in recent decades. Any range between a year and two years would provide similar results.
This slow and steady technique is called dollar cost averaging. As the opposite of market timing, perhaps a better name is market timeless.
It’s not a new idea, and I’m not the first to recommend it. To paraphrase Warren Buffett in a 2012 CNBC interview: You don’t know which stocks will do well, so buy a lot of them by holding index funds. And you don’t know when the market will go up or down, so spread your investment out with dollar cost averaging.
Hard to argue with Buffett’s view. But how’s it work in real life?
Nobody I knew in November 2007 was calling for the Dow to fold in half, for the economy to shrink 6%, or for the global banking system to teeter to the edge of collapse. Yet, that’s exactly what happened. How would one have fared investing at that top in 2007?
Let’s look at some real ETFs and real prices. US stocks (VTI), Treasury 3-7 year bonds (IEI), real estate (VNQ) and gold (GLD).
First, how did each of these four ETFs do if you went all-in on 11/15/07? As you likely recall, stocks and real estate went straight down while gold soared and bonds advanced steadily. Held patiently until June 2013, a million dollars invested in each of those single ETFs would be worth $1.3m to $1.7m today.
Now for the “market timeless” portfolio (below). It invests an equal amount – about 6 percent – each month in the diversified portfolio for 17 months starting 11/15/07. Again, I am picking the worst time to invest, since the largest allocation – 50 percent – is in stocks and they are about to go over a big cliff. Each month the same amount goes into the four ETFs. With the price movements over time, this means fewer shares of gold and bonds as they rise and more of stocks and real estate, which keep going down.
Once fully invested and held to today, the market timeless diversified portfolio ends up at $1.7m, $200,000 more than investing the full sum at the peak of stock prices.
There’s no magic here, just simple common sense. Invest, invest regularly, don’t try to guess, bet or predict. In this example, during and following one of our most dire market experiences, the market timeless portfolio delivers a nice return by buying less of things that are going up and more of things that are going down.
The next time you are looking at that cash wondering if now is the time to invest…the answer is yes. Take the market timeless approach.
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