This has been a phenomenal year for the stock market. At the time of writing, the S&P500 (SNPINDEX: ^GSPC) has reached the benchmark of 6,000 and continues to climb higher.
There is a lot of excitement about the stock market’s performance over the past two years, but many investors may be concerned about the possibility of a pullback or correction. Some may be hesitant to buy at what could be the market’s peak, and those who have a large portion of their money invested in stocks may feel like we are closer to the end of the bull market than the beginning. We could see a full market cycle take place quickly.
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But history has a clear answer about investing in stocks when they reach a new all-time high. And while the past does not guarantee future results, we can use it to guide our investment decisions.
One of the core principles of stock investing is that stocks as a group increase in value over the long term. Given that fact, it’s normal for the S&P 500 to trade at record highs. In fact, the market usually hits many new all-time highs in quick succession.
We saw that happen in 2024. Through December 6 of this year, the S&P 500 has achieved 57 new record closes. And that’s not even close to the highest number ever. Four years have passed since World War II, during which the S&P 500 hit more than 60 record highs. In 1995, the stock market closed at an all-time high 77 times.
In fact, 2024 looks a bit like 1995. That was the year that Alan Greenspan, then chairman of the Federal Reserve, successfully engineered a soft landing, avoiding potential inflation as unemployment fell without sending the economy into recession.
Jerome Powell, the current Fed chairman, is trying to achieve a similar feat by curbing high inflation without impacting low unemployment rates. So far he has been successful. The Fed’s first rate cut came in September of this year and the economy has responded well so far.
Investing may have been just as intimidating in 1995 as it is today. Stock prices and valuations soared that year. Furthermore, a technological revolution (personal computing and the Internet) was just beginning to take place, and while there was a lot of optimism about it, there was still uncertainty about how it would impact the world.
If you had invested in an S&P 500 index fund at the end of 1995, your investment would have increased by 155% over the next four years, with a growth rate of more than 26% per year. However, the dotcom bubble burst in 2000 and the market collapsed by more than 45% between early 2000 and October 2002. That said, investments made at the end of 1995 were still up 40% from the beginning of 2000. bottom of the dot-com crash.
Again, there is no guarantee that the late 1920s will be anything like the late 1990s. But history shows that the market can continue to rise for a very long time, even after strong price performance and new all-time highs. Investing at a record high – any record – is generally a good strategy.
You might be surprised to learn that the S&P 500, on average, performs exceptionally well in the period immediately following the day it hits a new all-time high.
Between 1970 and 2020, the S&P 500 generated an average five-year cumulative return of 78.9% if you bought on days when it closed at a new all-time high. By comparison, investing on any given day yielded an average five-year return of just 71.4%. The pattern also applies to shorter periods.
You might think you just have to wait for a bad day. But investing on days when the market closed below all-time highs resulted in worse returns over one- and two-year periods since 1970 compared to investing at all-time highs, data from JP Morgan.
It’s worth putting the historical returns in the context of 2024. Since hitting a new all-time high for the first time in over a year on January 19, the S&P 500 has risen more than 25%. That is far above the average return from investing at a record high. But it’s important to realize that the first in a series of record highs will deliver returns well above average.
The performance we’ve seen in 2024 is by no means an aberration, and a continuation into 2025 wouldn’t be unprecedented. Still, investors should understand that good times won’t last forever, and it’s important to have reasonable expectations.
It could become a lot harder to find good individual stocks to buy when the S&P 500 is trading at or near its all-time highs. Patient investors would do well if they are willing to get to know many companies, identify trends, monitor macroeconomic factors that may affect certain sectors, and value individual stocks. Finding a great company with shares trading at a fair price is a great recipe for long-term investment success.
But for those who don’t want to spend all their spare time researching individual stocks in the hopes of outperforming the S&P 500, index funds can offer a great alternative. An S&P 500 index exchange-traded fund (ETF) such as the Vanguard S&P 500 ETF (NYSEMKT: VOO) provides an excellent way to ensure your investment keeps pace with the benchmark index.
The ETF’s expense ratio of 0.03% means you pay just a few cents for every $100 you invest in the fund. In addition, Vanguard has a low tracking error, so the value of the fund never deviates too far from the index value.
The current makeup of the S&P 500 suggests there may be more opportunity among smaller companies. In fact, the S&P 500 hasn’t seen this much concentration in its top 10 stocks since 1970. Investors who want greater diversification than what the Vanguard S&P 500 ETF offers have several options.
One is the Invesco S&P 500 Equal Weight ETF (NYSEMKT: RSP). Instead of weighting each component of the S&P 500 by market capitalization, the equal-weight index fund, as the name implies, weights each stock equally, rebalancing once a quarter. Historically, the equal-weight index fund has outperformed the market-cap-weighted index over the long term, although that has not been the case over the past decade.
Another option is the Vanguard Extended Market ETF (NYSEMKT: VXF)which tracks all US stocks except those in the S&P 500. This ETF can be a great all-in-one solution to gain exposure to mid- and small-cap stocks with its low expense ratio.
Investors can also consider funds that track a more specific segment of the market, such as small-cap value stocks, which appear well-positioned to outperform in the current market after years of lagging the large-cap index. While the only way you can outperform the S&P 500 is by investing in stocks outside the index, it’s important to remember that this also carries the risk of underperforming the index. There’s no telling how long the current trend of large-cap outperformance will last, even if you use history as a useful guide.
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*Stock Advisor returns December 9, 2024
Adam Levy has no position in any of the stocks mentioned. The Motley Fool holds and recommends Vanguard S&P 500 ETF. The Motley Fool has a disclosure policy.
Is it smart to buy stocks while the S&P 500 is at an all-time high? History has a clear answer. was originally published by The Motley Fool
