By almost every measure, the stock market in the United States has hit several all-time highs over the last few weeks.
This has led several Simple Dollar readers to write in and ask whether or not selling stocks now is a good decision or not. Tom, for example, writes:
“With stocks being so high I am getting kind of nervous. You know the old saying of “buy low sell high” so I am wondering if I shouldn’t move my retirement savings into bonds or something else low risk for a while.“
The “buy low, sell high” maxim is a tempting one to look at right now. With stocks at (or near) an all-time high, it makes sense to look seriously at the “sell high” part of the equation.
The problem with “buy low, sell high” when it comes to something like the stock market is that it is very difficult to tell what the “high” is and what the “low” is.
For example, right now, it appears as though we are at a “high” – and, in comparison to stock market levels in late 2008, we certainly are.
However, we do not necessarily know where the rest of 2013, 2014, and beyond will lead us. If the stock market grows another 15% by the end of 2014, then selling now is a mistake. If it drops 15%, then selling now is a smart move.
This is when it’s important to point out that past performance is not indicative of future returns.
We can use the past history of the stock market to make an educated guess as to the future of it, but it’s only a guess. It’s really hard to rely on historical data because stock trading has changed so much over the past century.
For example, just thirty years ago, stocks were mostly traded by hand. Today, almost all stocks are traded electronically, most due to computer algorithms. We’ve also seen a rise in hedge funds and countless other changes in how people and organizations actually invest, as well as changes in stock market rules. You can’t expect everything to unfold the same today as it did even ten years ago.
Instead, the question you should be asking yourself should be centered around realistic long-term predictions about the stock market.
I am a firm believer in Warren Buffett’s suggestion that you should expect a 7% annual return over the long term from investing broadly in stocks.
The question I will always be asking myself about my retirement situation is do I need that 7% to reach my goal for retirement? Or can I make it with a smaller return?
The catch with that 7% is that it’s volatile. You might average 7% over a bunch of years, but that’s after a sequence of years that are 10%, 14%, -20%, 8%, 2%, and 11% (or something like that). When you actually reach your target date, you might have enough, you might not.
With something that has a lower return, like bonds or cash, the return is a lot less volatile. You might invest in bonds that return 3% in a much steadier fashion, for example.
If you can reach your retirement goals with a lower risk investment, then that’s the sign that you should jump ship. That way, you know you’re sailing securely into retirement without the bounces of the stock market.
Also, remember that this isn’t an “all or nothing” decision. If you move half of your money into bonds that return 3%, you’ll have an average annual return around 5% with some volatility, but not nearly as much.
So, what can you take home here? Selling high makes sense if you can move into something with less volatility and still achieve your goals. A high stock market may have pushed you to that point – and if it has, you should take advantage of it and lock in your progress.
If you’re not there, see how close you are and take advantage of this situation to move some of your money into something less volatile.
Remember, a high stock market isn’t a chance to time the market – it’s an opportunity to re-evaluate your personal goals and how close you are to them. That’s what matters – not the ups and downs of the stock market itself.