I have led several classes through Dave Ramsey’s Financial Peace University over the last few years. One of the lessons that has always drawn some skepticism from a few is the lesson on investing. In that lesson Dave talks about getting 12% on your investments. Particularly as the sting of 2008 was still very fresh in people’s minds, I would frequently get comments that no one can get 12% on their investments.
Well in 3 of the 4 years since then, the S & P 500 has in fact done at least 12% or better and this year it’s on a pace to possibly do double that or more. In fact, it has done so well in the last few years that it has recently topped all time highs. Which leads to the next thing that I’m beginning to hear frequently. Sure the market has gone up, but that just means we are due for a correction. Surely, it will be coming back down very soon.
Perhaps. It is certainly possible. That is the nature of the stock market in the short-term. The market is always more of a roller coaster than a gradual climb. But does a stock market high imply that we are likely to see the stock market correct itself by going down in the near future?
Does a stock market high guarantee a correction?
It does seem logical that when we are talking about something that goes up and down as the stock market does that we would see a drop after it hits an all-time high, but historically is this really to be expected?
I recently came across a study done by the DFA Research group that asked just this question. They looked at the daily closing value of the S&P 500 index all the way back to 1962. After each time the index reached an all-time high, they looked at where the index was 1 month, 3 months, 6 months, and 12 months later. Was there a discernible trend downward that would indicate a correction followed the high? Here is what they found:
- One month following the S & P 500 hitting an all-time high, 60% of the time the market was even higher
- Three months after hitting a high, 64% of the time it was higher still
- Six months after an all-time high, 71% of the time the market closed even higher
- And finally one year after an all-time high, 73% of the time the S&P 500 closed higher than it had been the previous year.
Those numbers are fairly similar to what was found on a normal average day of trading. The conclusion of the study was that there was no statistical evidence to show that hitting an all-time high had any correlation with what the market was likely to do next.
So the stock market is likely to go even higher?
So what does this all mean? Will the market continue to make money over the rest of 2013? Will we see a major correction and it will go down? Honestly, I can say I don’t have a clue.
What I do believe is this: The same things that have been true of the market over the last 100 years are still true today.
If whether the market finishes 2013 up or down makes a major difference in your financial plan, then you probably should not have your money invested there. Investing should be for the long-term. If you need your money in the next 5 years or so it should be kept in a safer place like a money market savings account or a CD.
What does this mean for your investment strategy?
Whether or not the stock market passes an all-time high or not should mean very little for your investing strategy.
Certainly after the dark times we saw during the great recession, seeing the market’s recovery over the last few years is encouraging, and affirms my belief in it as a good place for my long-term investments.
Your overall strategy though should not be affected by market highs or market lows.
- Pursue a strategy of slow, steady investing over a period of many years.
- Invest in good mutual funds that are spread across a wide variety of types of companies, industries, and locations, funds that have a long track record of success over a period of 10 to 20 years or more.
- And sometimes the best investments are paying off debt, especially debt with high interest rates, and building up a good emergency fund so you do not need to dip into your investments when Murphy comes knocking on your door.
If you do these things, I believe. over a period of many years you will be successful.
The worst investment mistake
While you should monitor your investments on a periodic basis, the one guaranteed way to lose at investing is by listening to the latest chicken little predicting another great drop in the market. The people who almost always lose are those who try to time the market. If you are bouncing in and out of the market based on the latest news you will find it very difficult to succeed. The worst mistake you can make is to continually try to guess what the market will do tomorrow, or next week, or next month.
So the bottom line, will we see a market correction in the latter part of 2013? Are the recent highs indicative that currently stocks are over priced? I have no idea. (And no one else can say for sure what the market will do in the short-term.) Statistically though looking at the last 50 years there is no reason to believe that just because we have seen recent all-time highs that we are likely to see the market go down in coming months. As for me I will continue to invest slowly and steadily regardless of the daily ups and downs we will almost assuredly see.
What thoughts come to your mind when you see news that the market has reached an all-time high?
Photo credit: AJC1 (creative commons)