Personal Finance & Money Asked on February 17, 2021
I was reading recently that markets are overvalued, and came across a term called the ‘Buffett Indicator’ from Warren Buffett:
The "Buffett indicator" divides the combined market capitalization of a country’s publicly traded stocks by its quarterly gross domestic product. Investors use it as a rough gauge of the stock market’s valuation relative to the size of the economy.
In summary this indicator points us to the fact that markets are indeed currently over-valued, at least according to Warren Buffett.
What I’m hoping to do soon is finally enter the market with normal best practices in mind: indexes and a well diversified portfolio. However, my instinct is telling me that this is a bad time to get started given market valuations.
I know the common advice is to never try to time the market, but at this time doing so seems more prudent than anything else. Is there any concrete reason why I shouldn’t wait?
(I'll answer in the context of the US market, but the same ideas apply to other markets.)
The US stock market is quite over-valued by many valuation measures. But markets can remain over-valued for quite some time. As you note, you shouldn't be trying to time the market, but you also don't want to do something dumb and lose money.
There is a lot of emotion in investing. Especially for people starting out. Instead of thinking about it as market timing, consider basing your investment strategy on minimizing your regret (unhappiness) of possible outcomes.
For example, if you invest 100% in S&P 500 and the market tanks 50% next month, what is your likely reaction? Some people will be very upset. Some people will be fine knowing that the markets go up in the long term.
If such a market crash would upset you, then consider 50% in S&P 500 and 50% in bonds. You'll lose much less in a market crash. Though you'll also gain less if the market continues to do well. Will you regret missing out? Then put more money in stocks and less in bonds!
Pick an asset allocation that lets you sleep at night.
Answered by gaefan on February 17, 2021
Normal best practices include investing a portion of your savings on a monthly basis. This follows the best practice of "not timing the market."
However, if you have a large chunk of money saved up, and you suddenly invest all of it, then in my opinion, both of those actions are guilty of "timing the market." It was timing when you saved a chunk of money in cash, rather than regularly investing it. It would also be timing if you plunged into the market with all of your savings. If you are already guilty of timing the market, it could make sense to use valuation metrics such as the Buffett ratio to decide when to invest.
If guilty of timing and seeking to repent of the practice, you could use a dollar-cost averaging plan to invest the chunk of money that you have in cash. Instead of plunging in, you could plan to invest the chunk in equal dollar amounts over the next 18-24 months. You can also start investing on a regular basis out of your salary, going forward.
Answered by Orange Coast- reinstate Monica on February 17, 2021
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