(PUB) Investing 2015

say that today’s U.S. stock market is not cheap—though whether it’s expensive is hard to tell. One thing we know for sure as 2015 dawns is that we can’t buy at 2009’s low, low valuations today. As inves- tors, we have to deal with the here and now—stocks aren’t as cheap as they once were. So what’s an investor to do? In short, if you aren’t invested or are currently invested but have some new money on hand (say, from a year-end bonus), I recommend that you put that money to work. If you are already invested and have a long-term strategy working for you, stick with it. I understand that no one wants to buy at a market top, but saying you won’t invest because the market is at a top and about to crash is plain and sim- ple market-timing. If you can correctly time the market, there are great gains to be made or losses avoided—that’s the allure of market timing—but it is incredibly difficult to do, and I don’t know of anyone who has done it consis- tently. Investors’ saving grace: A long time horizon and disciplined strategy can overcome unlucky timing. We’ve talked about this before, but as the market keeps hitting highs, it’s worth repeating. And an example is a good way to do it. Consider an inves- tor who had the misfortune of buy- ing 500 Index on the Friday before Black Monday (Oct. 19, 1987) when the index fund dropped 20.5% in a day. If that investor didn’t panic and sell, he would have had a gain of 2.1% one year later, and a total gain of 19.3% three years later. In the April 2014 issue, Jeff and I wrote about an investor who had the misfortune of buying at the market’s peak price each year for their 30-year- long investing career. The punchline: This hapless investor came out alright in the end, because time in the markets and a consistent strategy made up for incredibly bad timing. Or consider the charts above of long-term real total returns of U.S. stocks since 1926 and 1971—those are returns that include reinvestment of div- idends and an adjustment for inflation.

That Pattern Continues to This Day

Early Years of the Stair-Step Pattern

1,000 1,500 2,000 2,500 3,000 3,500 4,000 4,500

100 150 200 250 300 350 400

S&P 500 Real Total Return Peak Level Reached

S&P 500 Real Total Return Peak Level Reached

0 50

0 500

12/70

12/74

12/78

12/82

12/86

12/90

12/94

12/98

12/02

12/06

12/10

12/14

12/25

12/30

12/35

12/40

12/45

12/50

12/55

12/60

12/65

12/70

Source: Morningstar, Ibottoson SBBI.

Source: Morningstar, Ibottoson SBBI.

making successive new highs. I don’t know, and no one else will know, either, until after the fact. What I do know is that at some point there will be another correction and even a bear market— guaranteed. It has been roughly three years since we’ve seen a 10% correc- tion, so one certainly feels overdue. But, this isn’t something to fear. As Morgan Housel aptly put it in a December 5 Wall Street Journal article, “All past market crashes are viewed as opportu- nities, but all future market crashes are viewed as risks.” If we recognize ahead of time that tomorrow’s correction will become yesterday’s opportunity, we will be better able to weather those inevitable corrections, and maybe even take advantage of them. The price you pay is important, and given that U.S. stocks are not cheap, I wouldn’t expect the pace of returns we’ve seen recently to continue over the next five years—500 Index is up 15.3% a year over the five years through the end of 2014. If you are looking for cheaper stocks, many foreign stock markets look more attractively priced than the U.S. market. Whether you choose to invest in U.S. stocks, foreign stocks or both, the important thing is that you do invest. If you don’t, I can also guarantee that you won’t benefit from any gains 10, 20 or 30 years down the road. Staying disciplined, sticking to your strategy and objective, and spending time in the markets can over- come unfortunate short-term timing. If you’ve got time on your side and expect the future to be brighter than it is today, the time to invest is when you can. n

I have broken the data in half so that you can see greater detail in each time period, but both charts tell the same story. Stocks have historically moved in a stair-step pattern, where losses occur but are recovered and then surpassed. As you can see, there have been some stretches like the 1930s, ’40s, ’70s and 2000s, where stocks moved sideways. There have also been long periods like the 1920s, ’50s, ’60s, ’80s and ’90s, where stocks went on to make new high after new high without a major decline. Notice that this stair-step pattern applies to short time periods as well as the very long run. The chart below shows the growth of 500 Index (reinvest- ing dividends) over the past three years. 500 Index returned 73.8% over this stretch (15.8% in 2011, 32.2% in 2013 and 13.5% in 2014), but it wasn’t all smooth sailing in a straight line—mar- kets just don’t behave that way. Going back to the long-term charts, you might ask if we have entered a period where the markets will continue

Stair-Step Patterns Typify StockMarket Gains

$200

500 Index Total Return Historic Peak

$175

$150

$125

$100

3/12

6/12

9/12

3/13

6/13

9/13

3/14

6/14

9/14

12/11

12/12

12/13

12/14

The Independent Adviser for Vanguard Investors • February 2015 • 7

FOR CUSTOMER SERVICE, PLEASE CALL 800-211-7641