The Stock Market is at an All-Time High, What Should I Do Now?

Kevin Michels, CFP^®, EA

13 times this year the S&P 500 has closed the day at an all-time high.  And with the current price still hovering near the most recent all-time high in July, I often get asked this question by clients and prospects:

“Kevin, what are your thoughts on getting out of the market now while it’s high and jumping back in once it’s gone down?”

The problem with this question is that it’s overly simplified.  Before I offer an answer on the initial question, I have to ask a bunch more.

1) Is your entire portfolio invested in the S&P 500?  Probably not, therefore, when you hear the S&P 500 or Dow is at an all-time high it only partially applies to your portfolio.  For example, your portfolio might include 5 other asset classes such as small cap stocks, real estate, international stocks, emerging markets, and bonds.  Take a look at where these asset classes are right now in relation to their all-time highs:

If your portfolio is properly diversified and holds these or other asset classes, the most recent highs of the S&P 500 might not have as much relevance as you initially thought.

2) How do you determine when we’ve hit the top?  Back in 2013 the S&P 500 had an amazing year, returning 32% and closing at a new all-time high 45 times during the year.  I remember getting the same question back then as I do now, “should we get out while it’s high?”  Imagine if you would have sold out of your stocks in 2013.  It took about 2.5 years for the S&P to drop by 10% at which point it was still 20% higher than it was in 2013.  It took almost 6 years for it to drop nearly 20% at which point it was still 50% than it was in 2013.  And that’s not even including dividends.  As the S&P 500 reaches new highs and hovers around those highs you will continually be bombarded with news headlines and pundits’ opinions that we’ve reached the top and a large market correction or bear market is around the corner.  Eventually, those pundits will be right.  However, don’t be fooled into thinking that they or anyone knows when it’s really coming.

3) What are the tax consequences of getting out of the market?  If your investments are in a taxable account, what is the gain you will realize by selling your investments?  Depending on your account size and built-in gain you could significantly increase your tax bill for the year.  If your investments are in a tax-deferred account like a 401(k) or IRA no gain will be realized on the sale, but if you want to withdraw money from the account to invest or hold elsewhere you will pay income taxes (and potentially penalties) on the withdrawal.

4) What do you do with your cash once you’ve jumped out?  Once you’ve sold the investments in your portfolio what do you plan to do with the cash?  Logically, you’ll want to keep that cash in something conservative so it’s there when you decide to get back in.  So, do you keep it in your investment account for when the market corrects and a buying opportunity arises?  If so, consider the average money market rate is about 0.10%.  With inflation running at about 2%, you effectively lock in a loss of -1.90% per year.  Do you transfer the cash to a bank and buy a CD with slightly higher rates or put it in a high yield savings account?  You’ll have to consider liquidity issues, time to transfer money in between institutions, potential tax and penalty liabilities, and more importantly the inertia you’ll have to overcome in eventually liquidating the account, transferring the money back to your investment account, and getting back into the market.

5) At what point do you get back in?  This, in my opinion, is the hardest question to answer.  When things are good, as they are now, it’s easy to say, “I’ll sell and buy back in when the market has gone down by 15%.”  In reality, it’s not that easy at all.  How will you be feeling the next time the market drops by 15% or more?  News will be ripe with negative headlines about an impending U.S. recession, or global recession, or stock market meltdown, or a “repeat 2008”.  How can you be sure that when things are “going to hell in a handbasket” that you’ll have the discipline and perspective to get back into the market.  At that point, it’s not just a “tough” decision to make, as humans we are biologically and behaviorally wired to make the wrong decision.   

6) What is your backup plan if you don’t get back in at the right time?  This is where things can get really messy.   Assume you tell yourself you’re going to get out of the market and then get back in once it’s dropped by 15%.   You get step one right and sell at the peak.  The market goes down 15% and you start having second thoughts.  You’re sure it will keep going down lower and decide you’ll actually buy in once it goes down by 20%.  Subsequently, the market starts to go back up.  Before you know it, the market is only 10% away from its high, then 5% away from its high.  What do you do now?  Undoubtably you’ll be kicking yourself for not sticking to your original plan.  Do you get back in now, or do you wait for the buying opportunity to return?  What happens when the market climbs back to its original high and then starts setting new all-time highs and you still haven’t gotten back in?  Over the past 5 years it hasn’t been an uncommon experience for me to visit with people who have been out of the market since the crash in 2008.  Their stories are all somewhat similar.  The “lucky” ones sold out near the top in 2007/2008.  Some sold out in the middle or bottom of the crash in 2008/2009.  The market rebounded relatively quickly, and they all sat on their hands, not knowing what was going to happen next.   As the market continued to climb, they waited for it to drop again before they reinvested their money.   Eventually the market returned to its pre-crash prices and continued to climb.  Retirement accounts that could have been north of $1 million were stuck at $500,000 for the better part of a decade.

7) What is your purpose in trying to time the market and is there another way to go about it?  This is the final question you need to ask yourself and probably the most important.   What is your true purpose and intent in trying to time the market?  Most people will fall into one of three camps:

• They want to avoid the volatility of the stock market and only be invested while it’s going up.  I get this, the volatility of the stock market can be unnerving.  Especially as you get closer to retirement and your account balances are higher than they’ve ever been.  A 10% drop from $50,000 to $45,000 is much easier to stomach than a 10% drop from $1,000,000 to $900,000.  However, there is a much better way to go about reducing volatility in your portfolio than timing the market.  Simply allocate more of your account to bonds than stocks.  As a rule-of-thumb (for the record, I’m not a fan of rules-of-thumb), you should have at least 5 years’ worth of expected withdrawals in safe investments like cash, CDs, short and intermediate term bonds.   Not only does this reduce the volatility of your portfolio but it will also give your stock investments time to recover after negative markets before you sell them for retirement income.
• They believe they can time the market to earn better returns.  There isn’t much more I can say about this reasoning other than it’s just not possible, at least on a consistent basis.  Hopping in and out of the market in an attempt to earn a better return is a recipe for disaster for all the reasons listed above.   People with sudden windfalls seem to commonly fall into this camp.  This can be a windfall from an inheritance, selling stock options, selling real estate property, etc.  They fear the scenario of investing their windfall all at once only to see the market drop right after.  Dollar-cost averaging is a great solution in this case.  Design a plan to invest a portion of your windfall every month into the market over a 1-2 year timespan.  This mitigates the risk of a large market downturn but does take away some of the reward of investing all at once if the market continues to rise.
• They’ve lost faith in the entire system and are considering avoiding the stock and bond market altogether.  There isn’t a good solution for those who fall in this camp.  Our economy and financial markets are all tied together.   If the stock market collapses for good so do banks and insurance companies, all the FDIC and SPIC insurance money and government bailouts wouldn’t change that.

The Bottom Line

If you’re still considering timing the market or nervous about investing additional money while the market sits near all-time highs, remember the popular Chinese Proverb:

“When is the best time to plant a tree?”  “20 years ago.”

“When is the second-best time?”  “Now”.

It’s not about timing the market, but time in the market.  Time is the best ally you have when it comes to investing.

If you have questions about your investments or need help formulating an investment and financial plan, feel free to reach out to an advisor at Medicus Wealth Planning.  You can schedule a complimentary consultation by clicking here.