Ask the Readers: Is Now a Good Time to Buy Index Funds?
Published on - January 25th, 2008 (by J.D. Roth) A shaky stock market makes people nervous. Naturally, they’re scared of losing money. Alex, a reader in the U.K., wrote to say that he’s finally ready to begin investing, but he’s not sure that now is the time to do so. Should he wait?
I recently switched jobs to one that pays me better (and makes contributions to a pension!). My current savings are healthy enough to be considered an emergency fund; if I lost my job tomorrow and tightened my belt it would carry me through a couple of months of unemployment. I am 23.
I have never been so financially rosy, and I am certainly rosy enough to start investing. You’ve convinced me that index-linked funds (I’m talking about the things that track the stock market) are the way to go — a decent balance between risk and reward. But as we all know, things have been a bit rocky on the stock market lately.
Should I be investing now in a kind of buy-it-cheap kind of way, and accept that ‘plummeting prices’ just mean a loss of 1-2% that will be made up for in the long haul? Or should I wait a couple of months and keep that money in my current account, and make an investment in the new year when things are a little less volatile?
Alex is hoping to get some U.K.-specific advice. Because I’m unfamiliar with foreign markets, I’m going to use the U.S. stock market in my examples. I welcome comments that apply to all markets.
The short answer is: nobody knows what the stock market is going to do, and all attempts to guess simply amount to market timing, which is what the experts warn against. There’s a significant chance that the market will drop more than just 4-5% during the next year — it could drop 10-20%! But history has show that with time, the market will increase.
Looking at QQQQ, an exchange-traded fund that tracks the NASDAQ index, you can see that the share price tumbled 15% this month. But the price is still nearly double what it was five years ago. The market is volatile. Prices swing up and down. Looking at short-term history is baffling. But looking at the long term shows a general pattern of growth. Pay attention to the long-term — the short-term will only cloud your judgment.
For myself, I’ve decided to trust the advice I’ve read over the past few years, advice that says if I make regular investments in index funds, the value of my money will increase with time. 
It may not always increase — in fact, it may see some significant declines — but it will generally increase.
Indeed, when an index fund declines in value, it doesn’t bother me. I look at it as an opportunity for me to buy in at lower cost. But if an individual stock declines by a similar amount, I get very nervous. An individual stock is not diversified — if it drops, there are no other stocks there to buoy its value.
If you’re worried that the U.S. stock market faces a rocky future, consider tucking some of your money into index funds that track foreign markets. For example, I have money in EFA, which is an exchange-traded fund that tracks European and Asian stock exchanges. (EFA is not the only option — there are other index funds of this sort. It’s simply the fund that I decided worked well for me.) But be aware that foreign markets have their share of declines, too. This month, both QQQQ and EFA are down sharply.
Ultimately, only Alex can answer this question for himself. Only he can decide whether now is a good time for him to buy index funds. But my own answer is that every time is a good time for me to buy index funds.
Yesterday’s issue of USA Today featured a story called “Where’s the Best Place to Plant Your Money?” Here are some related articles from the Get Rich Slowly archives:
- What if the stock market makes you nervous? (This article includes links to risk-tolerance quizzes.)
- What the stock market decline means for you
- Saving and investing: What is a stock market index? (a video presentation)
- Intro to mutual funds: Index funds (a guest post from Vintek)
What about you? When the market’s down, do you get cold feet? Or do you view it as an opportunity to buy? What’s your advice for a new investor like Alex?
Updates: In the comments, Brad makes a very important point: “The crucial issue in making this decision is your time horizon. If you’re investing for retirement and you’re young, that’s a totally different ball game than if you’re investing to make money this year or next.” My comments above apply to long-term investors.
Here are two other video presentations related to this discussion. The second presentation is particularly important — the linked page also includes graphs demonstrating how time mitigates market fluctuations.
- Saving and Investing: An Introduction to Dollar-Cost Averaging
- Saving and Investing: The Impact of Time — READ THIS!
All of the videos I’ve linked to here are from Michael Fischer, whose Saving and Investing is an excellent introduction to the subject.
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The crucial issue in making this decision is your time horizon. If you’re investing for retirement and you’re young, that’s a totally different ball game than if you’re investing to make money this year or next.
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The stock market has always been and will always be volatile; it usually seems at its worst in the present because it is in your face rather than an incomplete memory.
Current prices should not play a roll in the decision to invest. For all we know stock prices may never be this low again…ever! The fact is, there is no way to know when the “best” or “worst” time to buy IS, only when it WAS (by then, there is nothing you can do about it).
If you are young, this will not be the only investment you make. There will be plenty of times in the future that will be better and plenty of times that will be worse. That’s just the way it works.
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Brad hit the nail on the head. If your goals are long term, this is a very nice time to buy. If your goals are short term I think buying right now is too risky.
Right now I’m buying in my retirement account, but a few weeks ago I (luckily, I think) sold the investments I’ve set aside for shorter term goals and opted for a CD instead.
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I was actually reading a good article about this yesterday, and although I can’t find the exact article, but the general consensus was that if you are looking for a safer fund to put the money in, large cap growth funds tend to do a bit better in a recession. The article was on MarketWatch, and if you click the Mutual Funds link at the top, there is a lot of good information there.
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I always view a long term investment as five years or more. Anything less than that should be put into high interest savings or CD’s. The five year mark will wipe out the volatility of the market
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Brad is correct, the crucial issue is time. Index Funds track a particular index (such as the S&P or Russell’s, etc.) If the Index does poorly so does the fund, and vice versa. Historically over the past 50 years the Market has provided about a 10% return, which means that time is the crucial issue.
Also, keep in mind that turnover of securities in an index fund’s portfolio is minimal, and as a result the index fund has lower management costs than other types of funds. This is appealing to investors. I have them in my portfolio.
If you have a good investment strategy in place, like the one I posted yesterday at my blog, then over the long haul, having investments in index funds won’t hurt.
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I have to admit, I am sorely tempted to borrow some of my money from (the domestic stocks portion of) my retirement account to pay off my second mortgage. The idea being that I am losing a few percent every month for the past few months, but if I paid down my mortgage, I would save 7% on the interest from the second mortgage, have instant equity, plus earn the 5% or so they (I) would loan me the money at.
I am probably going to stay the course, and leave it where it is, but what does everybody think of that idea? crazy?
Since I would be borrowing the money from myself, it would not be subject to income tax or penalties, and it would not show up on my credit report. True, I would lose out on probably 4 years of compounding, but its not exactly compounding as it is now anyway.
Also, I am 32, and this wouldn’t be the whole nest egg. Probably about 33% of it.
Thoughts?
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icup: Taking a loan from your 401k (I assume?) is never a good idea. You make a good case for it above, but by taking that loan you’re actually REALIZING the recent losses in the market (vs. leaving it in there long-term it shouldn’t matter in the end). Also (and this is a big one), you will get DOUBLE-taxed on your loan. First, you pay it back into your 401k with AFTER-tax dollars, and then when you withdraw it again in retirement, you of course get taxed again. For this reason, you may want to consider taking your contribution down some if you can (meaning, don’t give up any employer match), and put that directly towards the mortgage (or even better, redirect it from taxable investments or raise it some other way)
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I have no issues with buying into this time especially since I invest in index funds. But one thing JD mentioned above made me think about the method of buying in.
See, I tend to take one lump sum at the beginning of the year and put that into my fund. And that’s it for the year. For instance, we decided we would put $4000 into our Roth last year and instead of doing it spread out over months we just took $4000 we had and put it in all at one time.
Is this not a good idea? Is it better to spread your payments out over a year even if you have the money on hand? Or does it not really matter?
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Investing is long term, at least 5 years, if not more. When shopping for a mutual fund, look at their 5, 10 and 15 year rate of return. If they’re not 5 years old yet, don’t buy them. Look for rates of 12%. The stock market itself has a historic record of ~13% since inception. There are some mutual funds out there that are 30, 40 and even 70 years old that have rates of return like that.
I rolled my previous employer 401K over to an IRA with a mutual fund that’s been open since the 70′s and has a 12.5% rate of return. That was in August last year. Sure, they’re down 6% the last quarter, but they’re up overall since I opened the account. Albeit not up by much, but I’m not cashing out in a panic.
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It’s also important to note the role of a rogue trader had in the current downturn. It should have the effect of putting folks at ease.
If your time horizon is long, and you have extra savings, why wouldn’t you start investing.
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ah, I had not considered the double tax issue. That alone is reason enough to stay the course.
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@Covert7
There are two schools of thought on this. One is that spreading the risk with dollar-cost averaging works best. The other is that buying with a lump sum at the beginning of the year actually produces the best long-term results.
The only reason I mention periodic investments in the post is because that’s how most people buy into their 401ks, etc. Personally, I lean toward making lump sum purchases at the beginning of the year *especially* if the market has fallen 10% recently. Obviously, there’s no way to be sure it won’t keep falling, but to me it seems like 10% off is a good deal. If I had the money right now, I’d make a lump sum investment in my index funds.
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My answer to the people who are convinced the economic sky is falling is: “So what?” So what if the market crash predicted by x happens? My time horizon is 30-40 years.
If the economy behaves more or less as it has for the past hundred years, and as the experts say it will, I need to keep doing what I’ve been doing.
If the sky falls down and there’s a whole new paradigm for the economy and dealing with retirement, etc., um, how can we predict the right thing to do? I can’t. And other people can’t, either. That’s the nature of the kind of shift they’re talking about.
I actually tend to agree with a lot of what some of the sky-is-falling people say. I’m just quite sure they don’t know how to deal with it any better than I do, so I might as well prepare for the sky to stay up.
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One thing I don’t understand when people ask questions like this is their expectation of the market. I guess that’s a good thing because it shows how much I’ve learned. The need to think long-term has been repeated again and again – there’s still some people who haven’t heard of it, but for others it doesn’t seem to fit with the way they think about stocks.
What is it that makes someone who’s prepared to invest for the long-term afraid of their investments going down the next week? Do they think that at some point in the future the stock market will “fix itself” and start making money again? Do they think any decrease in prices is a permanent loss, even if they hold their investments until the prices goes up again?
I think taking on the assumptions behind their reasoning while reminding them of the timespan of their investment would be the best way to change their mind.
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Essentially, every investment contribution we make is “market timing.” Making a decision based on “what is best NOW” should not find its way in a long-term investor’s decision process.
Making a lump sum investment now is not necessarily a “bad decision” but it introduces a pshychological element that can be damaging.
Dollar-cost averaging is best for the average investor. If you invest in a lump sum at the beginning of the year, then you should do that EVERY year, regardless of the market environment. If you DCA monthly, then you should continue to do so. Consistency is the key to a long-term strategy…
To answer the question posed in the title of the post, index funds tend to outperform in rising markets. In times of uncertainty, especially falling markets, actively-managed funds do best. We are entering into a “stock-pickers” market and seasoned fund managers can navigate volatile markets. But these are thoughts for “advanced” investors…
Great post. Thanks…
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I would add to your update and Brad’s comment that trying to make money in stocks this year or next is not investing, it’s gambling.
In any 1 year period from 1927 to 2006, the S&P 500 has ranged from a -34% to a 41% return. However, the 20 yr return of the S&P has never been negative, and the 10 year return was negative only when purchased in the 3 years immediately preceding the stock market crash of 1929.
With this knowledge in mind, my answer to your question is that it is always a good time to invest in index funds. When the market is down, it’s an even better time to buy. The largest 10 year return in the S&P benefited those who invested in 1948 when the index was 15.2, down 12.4% from its 1945 price.
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Now is a great time for buying index funds if your time horizon is decades long. Keep buying throughout the recession and you’ll be happy later on…
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The reasoning that it’s dangerous to buy when the market is volatile goes against the grain of every personal finance book I’ve read. The market is always unpredictable, and holding off from buying now is a version of trying to time the market. If the investment is for the long-term (which I believe, unless you have scads of money to burn, investment should always be), now is as safe a time as any to invest in a diversified mix of different index funds.
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Everyone afraid of putting in long-term money when they’re scared of the market (a scarier time would have been when the market was at record high, IMO) owes it to themself to look at a chart of whatever index they’re buying over the past 40 years. These 2-3% bumps and dips we fret about on a daily basis nearly disappear and you get a nice smooth increase.
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QQQQ is still less than half of what it was in early 2000. Not every time is a good time to buy the index.
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@rstlne,
The NASDAQ (QQQQ) is but one index and heavily weighted toward the tech sector. It is not *the* index. A more diversified index covering the whole (US) market, such as the Wilshire 5000 or Russell 3000, would tell a different story.
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If you are afraid of losing money the stock market is not for you – at least not yet. Now is an excellent buying opportunity – but only if you will leave this money in the market for 5 years (that’s good advice in any economic climate). If you only have a thousand or so above your emergency fund you are probably not ready to hit the market just yet. My advice to you (and I’ve followed it myself) is to use this time to study the markets. See what picks you would make and follow them (without actually putting money on them) and see how you do – its a good learning experience. Also read, read, read – Boglehead’s Guide to Investing, Jim Cramer’s books, Suze Orman, Jane Bryant Quinn, financial websites (Kiplinger’s, CNN Money, MSN Money, Yahoo Finance, thestreet.com) – read everything. Even the quacks are worth reading so you’ll know how to spot a scam when you see it. Then, once you’ve educated yourself you’ll feel more confident of your actions (and you are also far more likely to make good decisions.)
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QQQQ isn’t a mutual fund, it’s an ETF. Also, it isn’t a very diversified fund at that.
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Good catch, Luther. I’ve corrected the post.
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Great points all. It really is about cost averaging down if you think the investment is sound. Good funds often get beat down with the deserving ones…
Buy Low and Sell High…
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Alex, I can’t speak for you, but I also just achieved a financial position that allows longer term investments (I’ve cleared my debts and built an adequate emergency fund). I started investing in a low-fee index fund earlier this month, making a lump sum contribution and scheduling automatic monthly contributions starting this month and continuing indefinitely.
In direct answer to your question: I’ve made the judgment that now IS a good time to invest in stock (and specifically in index-linked mutual funds). Especially because my plan has repeated contributions over time, any market decline is a chance to buy more shares for the same amount of money.
If you plan to buy into the stock market, it is important that your investment goal be long term and that you avoid looking at your goal as an accumulation of money. Instead make your goal to accumulate an ever greater number of shares in stocks.
In this way, you can see your continued progress even when stock values decline: your number of shares will continue to increase as you invest, and the rate of increase will rise when stock values decline.
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Wishing you a prosperous future
Daiko
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[...] 25, 2008 What prevents long-term thinking? Posted by siliconprairie under Finance Today’s post at Get Rich Slowly brings up an interesting question. Any time there’s a period of bad [...]
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If you have a long time horizon, it is always a good idea to make monthly contributions to stock mutual funds. Diversify, do some wise asset allocation, dollar-cost average, and rebalance at least annually.
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If you invest for the long haul as all investors should, it’s almost always a good time to invest. Some sectors may occasionally experience short term volatility however – financial for example.
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Heck yes! I started investing for retirement at 23, too, and that was in 2001. I’m so glad I did because I know people almost twice my age who don’t have the portfolio balance that I do. I’ve never been able to contribute more than $400 a month, and I’ve invested both in index funds and in more aggressive funds, but that’s another perk of starting young: I’ve been able to take calculated risks with my money — and so far, they’ve paid off very nicely — and I’ve done it early enough that my rate of return has beat the S&P 500 by at least 4 points every year. Those returns have added so much value to my portfolio that, thanks to the beauty of compound interest, I’m feeling pretty secure about where I’ll be when I’m 60.
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Following Brad’s comment, if your time horizon is less that 5 years you probably don’t want to be in the stock market at all.
Short term fluctuations are unpredictable, so there’s no sense in timing the market. Just dollar cost average and you’ll be set.
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Just pointing out that the FTSE All Share Index – the major diversified index in the UK – has exhibited similar behaviour to the S&P 500 in the long term. I think the annualised rate of return over 20 years is around 8%.
It’s also relatively easy to find trackers in the UK that copy ex-UK indexes to use to diversify overseas.
Or use some other sensible investment strategy, but probably now, like any other time, is a good time to buy and hold for the long term.
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All great information. I’m going to keep investing irregardless of the market with every paycheck until I don’t need the paycheck anymore.
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Hello,
Alex here. Thanks for your words of advice so far – they’ve been helpful. I see people have had some questions, so I’ll try and answer them to help other people with the advice-giving:
Q. “What’s your time horizon?” Long term or short term?
A. I don’t really have one. I can’t predict the future – I may not touch the money until retirement, or I may get evicted next week. I’ve paid off my immediate debts¹ and don’t have an extravagant lifestyle. So my bank balance will start increasing and I won’t have anywhere for it to go. I’ve been reading GRS for a couple of years now and one of the lessons it’s taught me is that it’s in my interest to 1. save early & often and 2. make my money work for me. So rather than have it sitting around earning 0.1% in my current account, I figured I should get myself some actual, proper savings.
Q. Why are you bothered about a dip at all, if you’re saving for the long term? “What is it that makes someone who’s prepared to invest for the long-term afraid of their investments going down the next week?”
A. It’s not so much that I’m afraid of it happening, it’s just that I think the game changes when you haven’t got money in already. If you invested 10 years ago then you’re already well ahead and just have to take this dip as part of it. But if I put in £100 today and it was worth £50 next week I’d feel like a fool – and be worse off than if I’d kept my money out of the market. And that’s kind of the crux of my question – does the game change because I haven’t got money in it already? Is waiting for the volitility to pass a good move or a bad one?
¹ I have a student loan, which is pegged to the rate of inflation so it is, essentially, free money. Contributions come off my monthly pay. As it’s at the rate of inflation I am better off not paying it off and using my money elsewhere. Also, if I stop earning I don’t have to make contributions.
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If you don’t have at least $10K, I’d suggest buying a single balanced fund, preferably one with a long track record. Check out Oakmark Balanced (OAKBX), T. Rowe Price Capital Appreciation (PRWCX), Dodge and Cox Balanced (DODBX, closed but available to some through 401ks) and similar funds. They are called balanced funds because they have both large and small stocks as well as bonds, and they tend to be steady earners who do well during volatile times. Oakmark’s numbers are comparable to the stock market as a whole with a lot less volatility. You mileage may vary, but I think keeping a balanced fund as a core holding is a great idea, particularly for those of us with a small portfolio. I got burned with index funds in 2001…
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I would like to tell you that I am 63 year old, female. Unemployed since August, 2007. Was a legal assistant for years, making good $ and contributing to a SEP employer sponsored account. After 8 years of employment at the lawfirm, lost my job in August, 2007. Thank God that every tax return was deposited in my savings account. That plus my unemployment $550 every 2 weeks (max. in FL)I was able to survive, but not for long. Found a job this past week making $3K less than what I was used to earning. Hopefully I will be able to match my last salary after the 3-mo. probationary period. To make a long story not too long, I must tell you that I invested with Vanguard. I have a Target Retirement account with Vanguard. Additionally, I have a Global Equity fund (Vanguard also)with very low fees which is something that Vanguard is famous for. I have from my last employer investments in a SEP with Lowes & Walmart stock as well as a fund with Balckstone/Merrill Lynch, (class C) and a Fidelity fund which was suggested to me by the M/L advisor. The funds that I chose on my own-(Vanguard with very, very low fees) are better than the ones the M/L advisor through my ex-employer suggested.
Good rule: Read, read. Go to Morningstar. They rate funds by stars. 5-stars is top. Click on each fund with 5-star. Compare with others. It takes doing your homework. We are in a volatile market, however, I feel now is BUYING TIME! Things will EVENTUALLY go up, even may skyrocket. I am not an expert, but my own choosings have fared better than the ones that were suggested to me by ex-employers’s retirement accounts advisor which only made him $$$.
Nothing like educating ourselves which enpowers us! Good luck, my friend. Let me know how you do.
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Now would probably be the wrong time to buy an index fund. Not only do the financials seem to have further to fall (and they can make up a large part of most funds), but the possibility of recession is very high. In fact not only do we seem set up for more surprises from the financials, but most other sectors seem to be failing as well. The much touted safe havens of foreign stocks appears to be an illusion as they fall in sympathy with the US. I would hate to see someone drop $10K in a fund, watch it drop 20% and then have to wait the next year and a half just to break even.
Having said that, dollar averaging (or Quid averaging for the U.K.) is normally a good method to build your finances. Every month you put the same amount in your fund or funds. The idea is that the market will go up and down, but generally grow over a long period and although you get the downturns, you also get the upticks. In fact, the past shows that after a recession here in the US, the market normally sprints ahead and not only gains what it lost, but betters itself.
Market timing is difficult. However, you would be in a better place if you held off till the fear of recession is past and the market stabilizes. Then you would reap the bull session without having lost initially.
Think about a nice 5% account. You might also look at Everbank. In particular, the Icelandic CD is paying 11% per annum on a 3 month CD.. (A caveat!!! Read the fees and redemption costs…) Then when the market cleans up it’s act buy your index fund. Better yet, buy a good book on the market and read up and think about sector and index ETFs.
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I agree with brad here. I’m the same age as Alex. I know that the market is very volatile, and there’s no real answer where the market is going. Thus, the amount of money I use is something that I can afford to lose or won’t touch it for a long time. I’m not comfortable (yet) with making my paper assets as a source of income.
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I hate to be the lone dissenter on this forum, but I think putting your money into an index fund right now is the worst thing you can do. Consider this:
The “credit crunch” we have witnessed so far was the result of about $100 billion worth of bad HELOCs, Special Investment Vehicles (SIVs) and whatnot being written off the books. There is still about $1-2 trillion left to be written off before this is all said and done. Housing prices are going to heavily contract, and the credit bubble will not just shrink, but pop. All of those bad loans were insured by what are known as “monolines,” which are insurance companies that insure loans, and have to pay out when it defaults. They are going to go belly-up because they simply don’t have the ability to pay off all those loans going bad. In turn, that means a large percentage of loans are going to lose insurance protection, reducing the security on those loans. This is going to affect everything that runs on credit, even the bond market that is known for stability and safety.
When that credit bubble bursts, you are literally destroying trillions of dollars. This leads to deflation and that is going to hit the entire world, mostly China and India with their rising middle classes. We haven’t seen deflation since the 1930s, but it’s coming back, no matter how much the Fed cuts rates.
The bottom line is that it’s not going to be pretty.
The stock market used to be a place where one could go to buy a small piece of a company, traders could go to trade and make money. Now, it is the retirement fund for most Americans, including millions of baby boomers about to retire. That is a scary thought when you consider it dropping a few thousand more points, along with the government sponsored bail-outs of the companies that made it happen. Once again, the profits were privatized, but everyone pays for the losses. I’m no expert, but that doesn’t sound like a free market to me. I’m glad that I am not retiring anytime soon.
For the next year or two, you might consider short-term treasury securities (like Vanguard’s VFISX) or keep things in cash. Your returns are not going to be stellar, but you aren’t going to keep pouring your retirement fund down the toilet.
If you feel like you have to invest in something, consider an inverse fund like BEARX. In layman’s terms, with an inverse fund, the value goes up as the stock market goes down.
This isn’t a matter of timing the market. It’s a matter of reading the writing on the wall. We are long, long overdue for this type of correction. The “stimulus” plan that Bush has outlined is pointless, and is simply designed to show that the government is doing “something” even if it is simply taking money from one pocket and putting it into another.
The good news is that you have a long time before retirement. The bad news is that millions of people don’t. Good luck.
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My thoughts, for what they’re worth:
As many said, Brad makes a very pertinent point. Time horizon makes all the difference.
Alex, my advice to you – especially in light of your comment – is this: don’t invest in the stock market yet, but not because the market has been volatile, declining, etc. Refrain from stocks because you’re not certain of your time horizon. Money invested in stocks should be for a _minimum_ of 5 years (some would say 10).
Your emergency fund may last through a couple months of unemployment, but – in your answer to the time horizon question – you imply there’s always a chance you would be evicted next week. That means you’re not yet comfortable with the level of your emergency fund.
This doesn’t apply to mutual funds, but dollar-cost-averaging isn’t as beneficial if you are investing in index-linked ETFs. This is because each contribution to an ETF requires a commission. That said, you can easily avoid ETFs for broad-market investing (ETFs are often better for specific sector/asset class investments, however).
Most investors tend to overweight stocks in their domestic country, which can leave them less diversified. I recommend a 50/50 split between domestic/international equity (and bonds).
In response to J.D.’s comment on dollar-cost-averaging versus lump-sum investing: dollar-cost-averaging is best for someone investing in mutual funds who doesn’t constantly watch the market. Lump-sum investing is better for making specific investments with “fun money” (i.e. money you’re not depending on). J.D.’s rationale for his preference of lump-sum contributions at the beginning of the year seems akin to market timing.
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Josh, while that could be the case this year, if you’re investing a lump sum at the start of every year that’s not market timing. It’s simply taking advantage of the fact that the longer your money is in the market the more you gain. If you invest 12 equal amounts over a year it will be in for an average of 6 months – if the returns are consistent over the year you’ll lose half a year’s gains.
It will never happen exactly like this, but if you can afford to make your whole investment as soon as possible instead of spreading it out over a year you’ll get an extra 6 months of returns on the money you invest. You’ll also apply dollar-cost averaging over the years, so it’s not like investing one amount and never adding to it. It’s hard to claim that investing for a shorter time is to anyone’s benefit.
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Silicon Prairie,
I agree with everything you said. However, you assume the lump sum becomes available once per year (e.g. a bonus, inheritance, etc.). I assumed (possibly incorrectly) one would save their money throughout the year in order to make a lump sum contribution.
J.D.’s statement was, “If I had the money right now, I’d make a lump sum investment in my index funds.” Earlier he said he leans towards making a lump sum contribution, “*especially* if the market has fallen 10% recently.” My comment hinges on the “if”s. Those conditions don’t agree with your advice to invest your lump sum as soon as possible, regardless of current market actions.
However, all my critiques of J.D.’s comment hinge on the cash flow timing assumption I wrote above.
Best Regards,
Josh
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Alex:
You can’t time the market bottom. One of the things that you have to accept about investing is the near certainty that at some point your investment will be worth less than it was the previous week. Which is why you need a long time frame.
If you have money that you are exceedingly unlikely to touch for the next 5 years, then investments are a reasonable place to put them.
Otherwise, if it’s really part of your emergency fund, then put it into a high rate cash ISA / savings account. Btw you can get a current account that pays more like 8% – I think it’s with Abbey.
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Don’t buy index funds, doing so exposes you to every overpriced, badly managed and downright criminal company in the index. In real (ie world currency) terms american index funds have been money losers for years now.
Instead diversify your money into different currencies. Buy stocks of well managed ethical companies with good track records and reasonable valuations. Buy and hold, move cautiosly. This is all easy with a little study.
Using this stratagy I have been up ~+16% year on year for many years now in real terms (way more in US$).
The current market down turn was entirely predicatble, I held more in cash and bonds waiting for it and I am currently (slowly because I don’t think it is over yet) buying bargins.
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Just a UK-centric note, as I see that a few posters are pointing Alex to US-based funds and firms an referencing US investment vehicles like 401Ks. While it is possible to invest in the US from the UK, it is a bit tricky and for a first timer it’s probably best that Alex sticks to his side of the pond. Also, differences in investment vehicles in the two countries make things interesting.
If Alex has the spare cash, it might pay to look into whether his scheme allows additional voluntary contributions.
Also, I hope that as much cash as possible is being held in an ISA (a tax-efficient wrapper that can be used for all sorts of investments, including cash). The new ISA season is not far away, so if he hasn’t used up his 2007/08 limit he should think of taking advantage.
If he needs money in case he is evicted, as suggested in a comment earlier, then I would say that’s not money to be tied up in investments. That’s an emergency, and cash to cover it should be taken from his emergency fund. If eviction or other horrible financial catastrophe is something that Alex is factoring into his investing timeframe, then it might pay to take a step back and revisit what he needs as an emergency cash back-up.
As a few people have said, if you think you’re going to need it before 5 years is up, or if you couldn’t afford to lose the lot tomorrow, it’s money that you shouldn’t invest in the stock market.
Other than that, if he still wants to go ahead then great. Personally I think an index tracker is OK to go with for now. Not the best time, to be sure, but over 40+ years (Alex’s timeframe) it’s not going to make too much difference in the end.
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John Egan: you say timing the market is difficult and then say, in effect, try to time the market, but Bear’s advice seemed more appropriate if the concern is a declining market. But both of you are in effect answering Alex with “No, now is not a good time to buy index funds or any other kind of fund.” You may be right. The question then becomes: how do you know when the right time is?
I think Michael’s advice of picking individual stocks is good if you have acquired the knowledge required to evaluate the companies and are willing to do your homework. That is where I’m aiming ultimately, but while I’m acquiring that knowledge and doing my homework, I’m using the indexed mutual funds as a “next best” strategy.
Don’t jump in on individual stocks until you know what you’re doing and why, and if you plan to do this I suggest reading Benjamin Graham’s book “The Intelligent Investor” and the Motley Fool books. These should help you learn when your actions make you a stock speculator (which you don’t want to be) or a stock investor.
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Wishing you a prosperous future
Daiko
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Re: Author: Daiko Comment:
“John Egan: you say timing the market is difficult and then say, in effect, try to time the market”.
Sorry… Maybe I wasn’t clear. To paraphrase Ben Stein, “Nobody knows which way the market is going.” As usual, there are two camps; The first feels we are heading towards a recession and the second feels that we will quickly pull out and regain prior market conditions.
My understanding is that we **have not** had all the **bad news** from the financials yet. It is said that we have not had all the writedowns on subprime loans. That means to me that there is a further drop in the financial sector.
This does not **even** count credit card problems, 2nd mortgage problems, auto loans, construction loans in the personal sector. Already reports are surfacing regarding these issues. Then we still have not really addressed the insurers of the subprime lenders, bond issuers or even lenders (bond issuers) for businesses (large and small). If you will, this is the 2nd shoe to drop.
We already know that contrary to popular opinion, investing in foreign companies (sic: as their economies have now grown large enough to support themselves)has resulted in a considerable loss of value. My own ownership of FXI (China Fund) is now worth 20% less than it was when I bought it for example.
Also, note that contrary to prior stock-guru’s opinion, the fallout from the financial mess **has** impacted every other sector of the economy, including tech, retail, auto, manufacturing, commodities etc… That is because they are all inter-related. (Lose your job at Citibank, you stop paying your credit card, auto loan etc and then eventually you lose your home. You also are not buying pizzas, clothes, new cars, computers, Vista software etc.. )
My concern is that someone would jump into this market on a downward plunge and can easily lose a lot of money. (Remember the rule of loss and recovery.. If you lose 50% of $10,000, you now have only $5,000. To get back to where you were, you must **double** your base amount of $5,000.)
Patience is a virtue that we all have trouble learning. And, the issue as always is risk/reward. The risk of losing another 20% is in my book, greater than the chance of gaining 20% right now. If I were starting right now, I’d park my money in a high-yield account and wait till there is an indication that we are coming out of this mess. In fact, this week around about the Fed meeting, I’ll probably liquidate my stock/funds (except possibly my dividend payers like ADVDX) and wait for financials to drop another 10% before coming back in the market.
Thx John Egan
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John,
Your idea is good, but very dangerous. Many people set goals such as your waiting for financials to drop 10% before I buy. What happens if it never reaches your price? Are you willing to spend the next 5, 10, 20 years in fixed income investments waiting for stocks to drop to a level you like?
Many people, seeing stocks rise, will proceed to buy at a price higher than they could have purchased for, far above their target price. The same though process leads one to sell when stocks drop, so money can be invested in fixed income. The end result in the long-run is that the portfolio bought high and sold low, thus failing to keep up with the returns of the index.
I fall back to my original comment, the longer you invest, the more likely your portfolio will have a positive return. I’m not in stocks to speculate on what will happen in the next six months or two years. I’m in stocks so I have the money to achieve my goals in 40 years.
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Chipping in with another UK view, and seconding blueto73′s point about an ISA (I think this is roughly equivalent to an IRA in the US, except it’s easier to get access to the cash, but I’m no expert on US acronyms). If you have spare cash, it’s a good place to put it – the current limit is £3000 in a cash ISA per year, and that rises to £3600 after April 5th. The £3000 still leaves you with £4000 left for stocks & shares (current year’s limit is £7000 overall, with next year’s limit being £7200), if you have that much available, and you can invest this through a bank or building society which will give you relatively low cost and very easy access to index funds. Having looked at the relative rates recently, the best I found for cash ISAs was through National Savings (odd, since the majority of their other accounts are rubbish) at about 6.2%. National Savings accounts are run through the Post Office although I think they are also available online (www.nsandi.com).
The one disadvantage of putting your cash into an ISA is that if you need to take any out, presuming you’ve contributed your full allowance in that year, you can’t top it up again until the next year starts. However, given that the returns are tax-free and this is a source of cash that Alex is not expecting to use except in an emergency, this is to me not a huge problem.
In addition, from 5th April this year, you will be allowed to roll cash ISAs from previous years into stocks & shares ISAs without it using up that year’s allowance. This means that, if Alex does build up more cash than he feels he needs as an emergency fund (and to me, two months’ worth of cash is not quite enough), he can shunt some of it into the stock market if he wants to.
Now is probably a good time to be investing in the stock market if Alex has a long term horizon, but not a good time if he may need the cash at some point in the next few years. I work with a bunch of stockbrokers, and one of them described investing in the stock market as like driving using only the rear view mirror to see – easy enough when the road is straight, but when it’s bendy the only way you can tell which way the road was going is by looking backwards – by which time you’re up to your axles in a boggy field (or worse, off a cliff).
In addition, unless there’s a good reason why Alex has his current account where it is, 0.1% is pants. I currently get around 4% at Nationwide, which is not the best rate available, but I also like their online interface, and it’s incredibly easy to set up, for example, an online-only savings account to transfer money into from my current account which goes instantly and can be put back in instantly if needed. I also put my ISA contributions in this way, and pay credit card bills. Having a look at his current account and seeing what else is available (and having a very close look at the T&Cs – Alliance & Leicester are all over the TV advertising astonishing rates on current accounts and savings accounts at the moment, but the terms are very, very tight indeed) is a good idea. There are accounts around that pay much better rates which means that if Alex does decide to top up his cash savings, at least what is sitting in his current account at the moment is actually doing something.
Also, Alex should remember that he does have exposure to the stock market – that’ll be where his pension contributions from his new job are going. I’d only advocate Alex putting more money into his pension as Additional Voluntary Contributions if he’s really, really sure he’s not going to want it until he retires, but if he can do this then it’s a good time to do it in my humble and very personal opinion (remember, I am NOT a stockbroker or a financial adviser, nor do I play one on TV – I just spend all day with a sensible collection of them and it does rub off).
Finally, re: index trackers – sometimes they work and sometimes they don’t. The FTSE100 in the UK is now at the same level (roughly, and depending on which day you look at the moment) it was at in 1998. I was looking at various funds a new client holds and an index-tracking investment trust that she put £6000 into in 1996 is now worth… £6030. Granted she’s had the income in the meantime, but at 3.5% gross (just over average FTSE100 yield) she’d have been better off with the cash in the bank.
Not a very exciting set of ideas – but my view would be that Alex is better off, in his current position, building up his cash cushion at the moment and waiting until he has more in the way of liquid funds in case of emergency before he thinks about getting into the stock market.
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