DOW 25,000? Why Not?

In January of this year the Dow-Jones Industrial Average (DOW) crossed the historic 20,000 mark to much fanfare from Wall Street and the national media.  By traditional measures, and depending on who you listen to, the market today is either fully valued or overvalued.  The question I’m getting more often now is, “When are we going to see a correction?”  My answer is, “I don’t know” (and neither does anybody else).  The more important follow up is, “Why does it matter (to you)?”

Both of my responses deserve greater explanation:

  1. “I don’t know.” In my thirty-plus years in this business I’ve never met a single person who could consistently call the stock market tops and bottoms…not one person.  Yes, a few people always get some attention for calling a particular top or bottom, but no one has successfully done this consistently.  And remember, you have to be able to make both calls accurately.  It’s not enough to just get the ‘getting out’ call right.  If you don’t get the ‘going back in’ call right you’ll leave profits on the table and in most cases you would have been better off simply living through the bear market.
  2. “Why does it matter to you?” If you’re invested properly, the ups and downs in the market should be a matter of little importance.  Even a brief study of the history of the stock market reveals that, in the short term, there is a lot of (unpredictable) volatility.  In the long term, however, stock market returns are about twice that of fixed income investments such as investment grade bonds, CDs, and money markets.  This significantly higher long-term return is what makes stock market investing attractive.

The key to successful investing then becomes how you manage your own decisions and emotions during highly volatile market periods or times when the market feels as if it has reached an ‘extreme’ (high or low).  The best way I know to do this is to structure your portfolio in such a way that you are not dependent upon selling stocks in order to raise cash for living expenses.  For a whole lot of people, it’s their paycheck that’s driving their living expenses and they have plenty of paychecks in the future which gives them time for a severe market correction to fully recover…on its way to reaching yet another stock market record high.

Building appropriate reserves

For those who do not have the safety of a steady paycheck to cover living expenses and must depend upon their investment portfolio for at least a portion of their expenses, it’s imperative to build several years of reserves in investments with minimal volatility such as money markets, CDs and high-quality bonds.  You may also want to focus your stock investing with companies with long histories of paying dividends.

To decide how many years of reserves you need, consider how long it took the past two biggest stock market sell-offs to fully recover:

  • 2000 Bear Market – At the time, this was the second worst bear market in stock market history with peak-to-trough losses of 33%.  The stock market took 60 months to fully recover.
  • 2008 Bear Market – This market supplanted the 2000 bear market as the second worst bear market in history with losses of 51%.  It took 51 months for full recovery.

Based on market history, you’ll want reserves enough to cover a minimum of 60 months.  While individual circumstances dictate appropriate investment reserve goals, we often hold ten years or more in these more conservative investments for our clients.

If you ask me the question, “Will the DOW hit 25,000?”, my answer is, “Yes!”.  When?  I don’t know, but I do know if you build an appropriate investment portfolio that allows you to remain invested during the highs and lows, you’ll see a DOW 25,000 and higher.