For decades, market analysts continue to try to call the top of market in an attempt to locate when the right time is to sell at a high in anticipation of a downtrend, and when it’s most opportune to short the market. Like I talked about in Lesson 39 and Lesson 59, the S&P500 averages roughly 10% annually before inflation since its inception in 1926, and about 7-8% after inflation (for arguments sake, the term “markets” will refer to the S&P500). Calling the top is impossible, and more so, futile, since on average your annual return is positive.
For folks that are more than 10 years away from retirement (let’s call it age 65), the behavior of markets should be of little concern as this historical average return is still proving true over a long enough time frame. There’s no need to get caught up in FinTwit and financial media around trying to sell and take profits at all time highs. The fact of the matter is that all time highs are the only way that markets can move higher. If the historical annual return for the S&P500 is 10%, well then obviously all time highs would have had to have been made at least once within a year’s period for a positive return to occur. Let’s look at some stock price charts below for some context:
Figure 1: SPX Chart from March 23, 2020 – August 27, 2020
The first chart shows the S&P500 following the sharp bear market in March 2020 during the height of the COVID pandemic within financial markets, out until August 2020. At that point, the market had risen 53% from the March lows, which seems absolutely unbelievable over a 5 month period. This was already an all time high compared to the levels in February 2020 before the market dipped. Surely a pullback must be in order right? Well September 2020 did experience a slight decline, but following that slight pullback, financial markets have absolutely surged since (September 2021) as seen in Chart 2.
Figure 2: SPX Chart from August 27, 2020 – September 3, 2021
The market rose an additional 32% shown in chart 2 following chart 1, for a total return of approximately 103% from the beginning of chart 1 to the end of chart 2. Selling at all time highs and trying to catch the top in August 2020 could have led to partially or completely missing out on massive gains that shortly followed. Is a pullback imminent now? Possibly, but timing when an all time high has been set and selling then is impossible. Afterall, a new all time high will inevitably be set in the future anyway given that we expect an average 10% annual return for the S&P500.
Let’s say you are able to time the market perfectly and sell at an all time high. Then what? When do you buy back in? Where is the bottom of the following downtrend and how do you time it? Truthfully, you can’t, and although you may have gotten lucky with timing the top of an uptrend in the market, chances are quite high you won’t time the bottom of the following downtrend to buy back in. In fact, it’s more likely you’ll get FOMO as the market trends higher and you will buy back into your positions at a higher price from where you sold them.
For people closer to retirement, it’s understandable that there is a greater sense of worry and uneasiness with having investments in public equities, and that is a feeling irrelevant of whether all time highs are being made or not. Timing may be regarded as more important to folks closer to retirement, but the argument there is that folks closer to retirement should already be transitioning investments to less risky and more fixed income vehicles like bonds or alternative investments with low beta or market correlation. There’s also a misconception that once you reach retirement, you will automatically pull out all of your investments and savings at the snap of your fingers. This is very unrealistic, and the reality is that your investments will stay put into retirement as you slowly draw from them over time to sustain your living costs and lifestyle. It’s unrealistic to expect to pull all investments out at one time since the timing may not be optimal. What if the market had just crashed 20%? Is it tempting to pull out all investments if the market has been making new all time highs? In either scenario, pulling out all investments at retirement is not a wise decision, aside from a tax perspective. Withdrawing all investments from a non registered account will be quite costly as all of the funds will be taxed as normal income, and the taxable rate will depend on the investment size being cashed out. In either scenario, it’s wise to pull out your investments during retirement in a series of tranches. Similar to dollar cost averaging into investments, you can dollar cost average out of investments as well. This way, you don’t have to worry about timing the market perfectly, in this case the market top, because it is impossible to do so. This is also beneficial from a tax perspective for investments in non registered accounts to ensure you are staying within lower income tax bracket, and to avoid paying higher taxes compared to pulling out larger lump sum amounts instead.
At the end of the day, ignore the noise of all time highs from financial news outlets and market “experts”, and stick to your investment plan that you have laid out for yourself or with your financial advisor. The only way to feel like you’re living above the clouds in retirement is to get your head out from over them before retirement.