A friend of mine came into some money recently and said that he was wary about actually investing the funds because the market is at an all-time high. He said that he knew he wasn’t supposed to time the market, but wanted to get my thoughts before pulling the trigger.
I told him what I tell everyone: as long as your time horizon is sufficiently long, it’s okay to go ahead and invest everything all at once. If that makes you nervous, it’s alright to dollar-cost-average by breaking up the investment into multiple chunks and invest it at regular, pre-planned intervals over what will ultimately amount to a short period of time.
The part of this conversation that struck me as interesting was the part about investing at an ‘all-time high.’ Of course, I understand the trepidation: you would hate to buy right in front of a big crash like the Tech Bubble or 2008 Financial Crisis.
But it reminded me of a newspaper article that I read 15-20 years ago that really got me thinking. My father-in-law reads the Investor’s Business Daily (IBD), a newspaper that focuses on the stock market and provides buy lists, ratings and other editorial features that you don’t see in other newspapers.
The article that caught my eye basically said that investors should check out their list of new highs published each day to find stocks that you should add to your portfolio. For me, that was anathema because I felt like looking through the list of 52-week lows was a better place to find bargains.
The point of the IBD article was that something is going well with stocks that are hitting their all-time highs and the market is reflecting that positive news. They argued that stocks on this list don’t go higher thanks to analyst reports or publicity stunts, but because people are willing to pay a lot for the stocks.
While it was a foreign concept for me, it held a certain intuitive appeal: if a stock is trading at an all-time high at a price of $10 and doubles to $20 in the next year, it was hitting new all-time highs constantly: $10.01, $10.02, and $10.03 – not to mention $11, $12, $19 and $19.99.
I had seen the opposite hold true as well: stocks that fell to a 52-week low frequently went lower – just because something went down didn’t mean it couldn’t go a lot lower.
Although I didn’t realize it at the time, I was getting a lesson in momentum investing, something that we do in a much more systematic way today with mutual funds. Academia discovered that stocks that have gone up relative to their peers tend to continue to gain more than their peers for relatively short periods of time – six months to a year or two.
Academics disagree about why momentum might work, but the data is crystal clear: people who say that momentum doesn’t exist are a bit like the folks who thought that the earth was flat or that the sun revolved around the earth. There’s just too much real word data to argue that momentum doesn’t exist.
Now, you can surely argue about whether momentum is a good investment strategy or not, and there are some arguments against momentum investing, most notably that there is a lot of trading, which increases costs. Obviously, we’ve evaluated the negatives and think that the pros outweigh the cons.
Unfortunately, momentum doesn’t tell us much about where the market is going. We can’t say with any confidence that because the market has gone up recently that it will continue to go up.
Momentum works with individual stocks when compared to other individual stocks (or bonds, or commodities or currencies), but it doesn’t really work when you are simply looking at one asset (like the overall stock market) over time. In academia, they call this cross-sectional momentum versus time-series momentum.
So, the advice to my friend would be unchanged if the market was falling. Current market conditions were not a factor in my recommendation. I mostly want him to get invested and try and forget the day-to-day market noise so that he can focus his attention on his long-term goals.
It’s the same advice that I give clients and what I do for myself: I’m fully invested at all times and every day that you don’t sell, you’re buying.