If you’re feeling jittery about investing right now, you’re not alone.
The stock market is on track for one of its worst years in modern history: The S&P 500 (^GSPC 0.48%) index of top large-cap stocks is down 18% from its peak at the beginning of the year. A combination of fears of a recession, inflation at 40-year-highs, and rising interest rates have turned the pandemic rally upside down.
If you’re wondering whether it’s safe to invest in the S&P 500 right now, the answer is that it depends. First, let’s take a step back and ask a few questions to see what kind of investor you are.
Image source: Getty Images.
What’s your time horizon?
Investing in stocks is risky. There’s no guaranteed return, and bear markets can last for years. However, investing for the long term — five years or more — is one way to smooth out those risks.
Having a short time horizon, in other words, makes investing in the S&P 500 riskier. If you’re planning to invest money you’ll want to use in another year or two, putting it into the S&P 500 leaves you at risk of losses. The stock market could slide further into a recession, and interest rates could continue to climb, squeezing consumers and businesses and making bonds more attractive by comparison. But there’s also the possibility that stocks could soar over the next year if inflation cools off and the Federal Reserve pumps the brakes on rate hikes.
On the other hand, if you’re planning to invest for five years or more, you have a much greater chance of making money in the S&P 500, as you’ll smooth out the current volatility and risk of a recession. Historically, the S&P 500 has returned about 9% annually with dividends reinvested. While you’re not guaranteed a 9% return, investing with a longer time horizon makes it more likely that your returns will resemble the historical mean.
Do you think you can time the market?
Spoiler alert: You probably can’t. Vanguard founder Jack Bogle said of market timing, “I don’t know anybody who has done it successfully and consistently. I don’t even know anybody who knows anybody who has.”
While everybody wants to get in at the bottom of the market, you’re better off investing set amounts at regular intervals through a dollar-cost averaging strategy into stocks, with the knowledge that the market will rebound eventually. What happens in the next year will depend on inflation, the Federal Reserve’s interest policy, corporate earnings, and other factors.
It’s impossible to accurately predict all of those things and to time the market successfully.
Would you rather get a 4% yield?
“Safe” is a relative term. If you’re looking for absolute safety, you’re best bet is buying Treasury bills. Right now, you can get a 12-month Treasury bill yielding 4.6% and a 2-year for 4.45%. Longer-dated Treasuries pay slightly lower yields because the yield curve is inverted at the moment, but if you’re content with a guaranteed 4% return, Treasuries are a better choice for you than stocks.
On the other hand, if you’re looking for higher returns, especially over a long period of time, the stock market is probably a better bet. The risk of uncertain returns in the stock market is the price you pay for higher returns over the long run.
Bear markets can be rewarding
It’s scary to invest during a bear market. When stocks are down, it seems as if they could easily keep falling, and often, they do. That’s a risk of investing during a bear market — or any market, really. But bear markets can also be rewarding opportunities for investors, as we saw in March 2020. Even if you had bought stock immediately after Lehman Brothers failed in September 2008, you would have had a gain within a year.
It’s worth remembering that the S&P 500 has recovered from every bear market in its history, and since the current one looks like a normal part of the economic cycle, there’s no reason to believe that stocks won’t recover when the cycle turns.
Stocks go on sale during a bear market, which is a good thing if you’re a net buyer of stocks because you can buy more of them.
Investing in the stock market is never absolutely safe, but right now, investors are being compensated for taking on additional risk. With a longer time horizon, buying an S&P 500 index fund right now will almost certainly pay off over the long run.
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