I am reaching out as a young person living a very low-cost-of-living lifestyle in a medium-cost-of-living area. Right now I am investing a large percent of my income every paycheck in retirement. I have a large percent of my net worth in cash (around 50%) and am waiting for a market drop based on the CAPE ratio of the financial markets right now. Should I dollar-cost average into the market right now? Or should I be waiting until the Fed starts reversing rates to put large chunks of cash into the market?
With so much of your net worth being held as liquid, I can understand why you’d be tempted to wait for a market dip, and then drop a large amount of cash into your investments. You mentioned the cyclically adjusted price-to-earnings (CAPE) ratio—one of the ways that investors technically analyze whether the market is over or undervalued—as the way you’re trying to determine the best time to jump into the market.
Many investors do in fact use price-to-earnings ratios to determine whether they do or do not want to buy a stock, so I don’t want to dismiss your use of this formula. But you haven’t told me what kind of investor you are. Would you consider yourself more advanced, or closer to a novice? You mention that you’re investing for the long term but not how much time you have to watch the market and do a technical analysis of the indices, or the stocks you’re interested in.
And for that reason, given that you’re someone who has a long-term objective of investing for retirement, I would say forget all about calculating CAPE ratios, make it easy on yourself, and dollar-cost average. Analyzing the market and timing the best points of entry is difficult even for the most skilled traders, and there’s a greater chance you’ve missed out on some opportunities already. So just jump in and remember that how much time you have in the market will always be more important. Besides, if you’re waiting for the Fed to stop raising rates, you’ll be waiting quite a while: the Fed has already made it quite clear it has no plans of stopping rate hikes as inflation remains elevated above its 2% goal.
By dollar-cost averaging, you can take the emotion, effort, and risk out of the equation, and instead, invest regularly over time. This does bring you the possibility of lower rewards, but given that the markets are down more than 15% since this time last year, it’s likely you will be pleased with your returns. Alternatively, you can take the risk, invest a large lump sum now, and dollar-cost average going forward.
Either way, I wouldn’t recommend waiting—with each passing day, you’re missing out on gains.
The Federal Reserve. "Panel on 'Central Bank Independence and the Mandate—Evolving Views.'"
S&P 500. "S&P Dow Jones Indices."