digest
Short Summary
Main recommendation: Do not try to time the market; the evidence suggests staying invested rather than selling or holding back new cash based on valuations or market fear. Valuation signals like the Schiller CAPE show a weak tendency toward lower future returns when stocks are expensive, but that relationship is too unreliable to act on, and dollar cost averaging is itself a form of market timing that usually underperforms lump-sum investing.
Key Points
- The Schiller CAPE (cyclically adjusted price-earnings ratio) shows a link between high valuations and lower future returns, but the strong result seen in hindsight disappears when investors only use data available at the time, as the AQR analysis shows.
- Even when a valuation-based timing strategy added value over 1900 to 2015, it underperformed from 1958 to 2015 because valuations can stay high or low for decades.
- Momentum means stocks that have risen tend to keep rising for a while, so selling after valuations look high means betting against a well-documented pattern.
- Most of the market's returns occur on a small number of days, so missing those days sharply reduces long-term returns.
- Dollar cost averaging is a form of market timing and, in Vanguard's 12-month tests across the US, UK, and Australia, lump-sum investing beat it roughly two-thirds of the time.
Details Worth Noting
- Concrete instructions: The speaker does not give a step-by-step method. The actionable guidance is to stay invested rather than market time, to avoid selling equities or delaying new cash because of volatility or record prices, and, if you are sitting on a lump sum and feel nervous, to use dollar cost averaging instead of waiting on the sidelines for a perfect moment (it is statistically suboptimal but better than not investing).
- In the S&P/TSX Composite Index from 1977 through 2018, the annualized return was 9.72%; missing the single best day dropped it to 9.48%, and missing the 15 best days dropped it to 7.44%.
- The 2012 Vanguard paper "Dollar Cost Averaging Just Means Taking Risk Later" tested periods of 1926 to 2011 (US), 1976 to 2011 (UK), and 1984 to 2011 (Australia) across stocks, bonds, and a 60/40 portfolio.
- The speaker notes that the sample with hindsight bias overstates the valuation effect, and that a real investor would not know future valuations when sorting.
- Trading costs and taxes from jumping in and out of the market can further reduce returns, depending on circumstances.
Bottom Line
Market timing is hard to do successfully, and the feeling that the market is uncertain is not a reliable basis for decisions, so staying invested is the more evidence-supported path.
