Ask the Analyst: Should I wait to invest new money?
Think about your goal and time horizon when deciding whether to invest during an uncertain economic environment.
This article originally appeared on our US website. It has been amended for an Australian audience.
In this Ask the Analyst series, I’m answering your questions about investing, personal finance, and retirement planning. Today’s question:
Given the risk of recession, do you think it wise to avoid investing new money until the outlook changes?
At first blush, this approach sounds perfectly reasonable. Stocks frequently lose value during economic downturns; our previous research found stocks were down during five of the eight most recent recessionary periods. Although the economic picture has been positive overall in recent months, a few warning signs have been emerging, such as rising corporate bankruptcies from postpandemic lows, higher oil prices and other inflationary pressures, alarming government debt levels, declining consumer sentiment, a potential slowdown from the Fed’s recent rate hike, and interest rate increases from the RBA.
However, it’s impossible to predict if or when a recession will actually happen. In the fourth quarter of 2018, for example, many market commentators were predicting an economic slowdown in 2019, which didn’t materialise. More recently, a broad consensus of economists and market strategists predicted that the Fed’s aggressive series of interest rate hikes would tip the US into a recession in 2022 or 2023, which also didn’t happen. Closer to home, indicators around unemployment have been slowly tipping, and cost of living pressures are crushing consumer sentiment.
The cost of waiting to invest until things get better can be steep. Morningstar’s Jeff Ptak found that an investor who missed out on the 10 best trading days of the year would have experienced a performance penalty of 2.4% per year. In my own research, I’ve consistently found that even the professional portfolio managers who run tactical asset allocation funds (which are supposed to ramp up their equity exposure prior to bull markets and vice versa) have consistently failed to outperform a static portfolio mix of 60% stocks and 40% bonds.
This means that as long as you’re investing for a long-term goal, it’s usually better to invest all at once instead of waiting for things to improve. If you’re worried about potential negative returns in the near term, you could invest small amounts over time instead (also known as dollar-cost averaging), but that often leads to lower returns. The reason is simple: Statistically speaking, the market goes up more often than it goes down, so keeping money off to the side usually doesn’t help.
However, it’s important to make sure the types of assets you’re investing in are a good fit for your specific goals and time horizon. For example, if you’re trying to build up a deposit to buy a new car or house in the next five years or so, lower-risk assets (such as investment-grade bonds) would be more appropriate.
Our Role in Portfolio framework expands on this idea. In a nutshell, riskier assets, such as stocks, are a better fit for long-term goals because they’re more likely to generate losses in the short term but have better growth potential over longer periods. Investing in stocks would be appropriate for money that you won’t need to tap into for at least 10 years. Many different things (including market downturns and recessions) could happen during a period of 10 years or more, but stocks have historically bounced back over longer time horizons.
Have a question for me?
In this monthly column, I answer questions from readers about investing, personal finance, and retirement planning. (Note: I’m focusing on questions that are of general interest to many of our readers, not personalised tax advice or portfolio recommendations.) You can submit one by filling out this quick survey.
