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Record highs! Time to sell?

The problem is that all of these phrases are backwards-looking, and investment decisions should be made on a forward-looking basis.

Articles by Dan Egan

By Dan Egan
Managing Director of Behavioral Finance & Investing, Betterment  |  Published: April 2, 2013

This accords well with attempting to “sell high”, and we can see that some of our clients are clearly “banking gains”, “selling at the top”, and “reducing risk”. The problem is that all of these phrases are backwards-looking, and  investment decisions should be made on a forward-looking basis.

So should you sell when the market hits a record high? Do “high” prices (that is, days when the S&P500 was higher than it had ever been prior to that point) predicts poor subsequent performance? Be aware that by considering this, you’re trying to time the market, and attempting market timing is why most individual investors under-perform a simple buy-and-hold strategy.

So before you start “banking gains”, consider the following points:

  1. High index prices are always reported in nominal terms, not inflation adjusted. If you look at inflation-adjusted prices, we’re not at a high. Check out this Planet Money episode: The Dow Isn’t Really At A Record High (And It Wouldn’t Matter If It Were) : NPR
  2. Regardless of the subsequent price returns, you’re missing out on the dividends during that period. Dividends tends to run at about 2% for US equities, higher for international developed equities.
  3. Finally, let’s test the implied idea that “record high prices predict bad subsequent returns”.  Using daily S&P500 data since 1954, we can tag days as “record highs” and “every other day”. There are 1,069 “record high” days, and 14,842 “others” since 1954. We can now compare subsequent 1 year returns of record highs versus regular days. The graph below summarizes the distribution of returns for “record highs” and “others”. There is no systematic pattern for record highs to precede bad years – the median return is almost exactly the same.

 

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