Quite frequently I get asked how I think about potentially investing at the top of the market with an inevitable market crash (ala GFC) around the corner. The one thing I agree with is that a market crash is inevitable, but that’s about it. I didn’t bother calculating historically how many all-time highs the market achieved as the point would be moot given we know how the market has evolved and grown in the long-term.
It’s true that if you did invest at the peak of the market, it’s possible you’ll suffer poor returns for a significant period of time. For example, if you invested $1000 in the market index in 1929, you would not have broken-even until 1955. Timing the market is difficult, and I believe it can be quite costly. So how do you mitigate such a scenario? The benefit of asset allocation and stock diversification is well preached, but often forgotten is the element of time diversification. There is no better example of time diversification than with a pure, disciplined dollar cost averaging strategy – that is, you continuously invest a fixed sum each month into the market, whether it goes up or down.
So to bring the point home, let’s assume our investment journey began in January 2007 – a full 18 months before the GFC went into full force. To put some context around January 2007:
- S&P500 was up a healthy 13.6% in 2006 and trading at 15x forward P/E
- GDP came in at 2.7% growth for the full year of 2006
- US unemployment rate was 4.60% as a 1 Jan 2007
Here’s the chart of what a dollar cost averaging strategy on a range of stocks (from high growth to defensive staples) would yield over the next 5 years (can you spot the GFC?). As a comparison point, I’ve overlayed cash invested at 2%p.a. interest compounding monthly.
The key takeaways are:
- If you have the luxury of investing with a long-term horizon, use it
- If you can’t predict the next crash then you should time-diversify with a consistent, disciplined approach
- Buying quality companies with sound future prospects is more important than picking the bottom
I’ve met very few highly successful stock market “investors” or “traders” and I could not help but notice a very specific pattern as to why most people fail to make money investing in stocks. We all seem to understand that the stock market goes up over time (with a long-run average return of 9% p.a.) but yet many individuals fail to even achieve the market average or worse yet, erode their capital. So let’s look as to why…
Blackbird Capital 