2018
Nov 13
Ask Cadence: If I haven’t participated in the stock market gains over the last couple of years, will my retirement be negatively affected as a result?
by Cadence WM |

Put simply – no, and here’s why. Think about it this way: Stocks at any point in time can be ranked on a scale of one to ten based on how expensive they are. The vast majority of the time, they’ll score somewhere between 3 and 7 where they’re neither cheap nor expensive. This is where one can have a traditional exposure to stocks based on the timeframe of their goals and risk tolerance. If stocks are scored below 3 and considered cheap, one might take a little more “risk” since over time prices stand a much better chance of being higher than lower. When price is low, there’s a margin of safety.

On the other hand, when prices are over 7 one could be forgiven for having less exposure to stock since we know from history and basic math that at some point stock prices will settle back down. At present, U.S. stocks are scoring a 10 and they have been for the last couple of years. There is simply no margin of safety. In time, and we’re seeing this play out this month just as it did in February, prices will begin reverting lower. Knowing when this begins and how it plays out is impossible, which makes participating in late-inning market gains extremely perilous.

So, in the context of valuation, missing a couple good years when markets are cheap or even fairly valued would be hard to make up. This is because at reasonable price levels, we have no reason to believe that large losses associated with mean reversion are coming. As a result, gains made from reasonable price levels usually stick and don’t evaporate over longer periods of time.

However, and this is extremely important to remember, stocks are not currently cheap or fairly valued. Any gains markets have experienced lately will likely vanish when prices come back down to earth as they always have. For example, had one missed out on the final two years of the bull market leading up to 2007, it would have cost them 33% in gains. However, from the peak in October 2007 through the market’s bottom in March 2009, the S&P 500 was down approximately -55%. So the question is, how important would those 33% in gains have been to your retirement if you then went on to lose -55%? The answer is not very important. The total return (or loss in this case) from October 2005 until the market low in 2009 would have been -42% even after taking into account the 33% gain in the final two years of the bull market.

The moral of the story is when stocks or any investment for that matter are too expensive, the chances are good that upcoming losses will wipe out any gains made in the short term. No, your retirement has not been set back if you haven’t fully participated in the stock market over the last few years. If anything, it may end up being more secure as a result.