Navigating Record-High Valuations: Why I’m Staying Invested

Key Points

• The Shiller cyclically adjusted price-to-earnings (CAPE) ratio indicates the S&P 500 is currently at its most elevated valuation since the year 2000.

• Even with elevated valuations, long-term investors should maintain confidence in acquiring shares.

• Mitigating concerns regarding high valuations can be achieved by diversifying into mid-cap, small-cap, and international equities.

On one hand, all-time highs in the S&P 500 (SNPINDEX: ^GSPC) benefit investors. Rising stock prices, the artificial intelligence (AI) boom driving excitement, and millions of American households accumulating wealth should theoretically make everyone happy.

However, many investors are currently anxious about the stock market due to its robust upward trajectory. Concerns are mounting that the bull market may be nearing its end and that what goes up must inevitably come down. According to widely tracked metrics—such as the Shiller cyclically adjusted price-to-earnings (P/E) ratio, or CAPE ratio—the market appears historically expensive, raising questions about whether future corporate earnings can justify today’s elevated share prices.

As a cautionary indicator, the S&P 500’s CAPE ratio has not reached this level since 2000, a period right before the dot-com bubble burst.

S&P 500 Shiller CAPE Ratio data by YCharts

Does this mean the stock market is doomed and a crash is imminent? No one can predict future stock market prices with certainty. Historical trends do not always repeat themselves. However, even if a market downturn lies ahead, I will continue to purchase stocks for the long term.

Here are a few reasons why.

Image source: Getty Images.

1. For Long-Term Investors, There Is Never a “Bad Time” to Buy

Many investors worry that the market will crash immediately after they purchase shares.

It is understandable to feel anxious about buying stocks, as they carry inherent risks, and market downturns, corrections, and crashes do occur.

Rather than worrying about what might happen tomorrow, consider what is likely to occur over the next five to ten years. Is the stock market the best place for your capital to work over the long term? Most of the time, the answer is yes, as the broader market delivers robust gains for long-term investors.

Since 1928, the S&P 500 has delivered an average annual return of 10% over the past 98 years. This includes navigating some of the most severe economic crises and crashes in American history, such as the Great Depression.

Most long-term investors should ignore short-term anxiety and simply purchase a low-cost exchange-traded fund (ETF) that tracks the S&P 500. The Vanguard S&P 500 ETF (NYSEMKT: VOO) is an excellent choice. Over the past decade, it has delivered 15% annualized returns.

2. I Maintain Diversification Across U.S. and International Stocks

Some investors worry that the S&P 500 has become too heavily weighted toward highly valued AI stocks, making it vulnerable to a tech sell-off. However, you do not have to buy only the 500 largest publicly traded U.S. stocks; you can achieve greater diversification by owning mid-cap, small-cap, and international stocks.

I own the Vanguard Morningstar Total Stock Market ETF (NYSEMKT: VTI) because it includes over 3,500 U.S. stocks, rather than just the largest companies. I also hold international stocks, as I want to invest in global growth opportunities rather than limiting myself to America.

A great way to achieve this is to purchase a broadly diversified international ETF, such as the iShares Core MSCI Total International Stock ETF (NASDAQ: IXUS). This fund holds 4,494 stocks from companies worldwide. It has delivered annualized returns of 9.42% over the past decade and an impressive one-year return of 27.55%.

3. I Employ Dollar-Cost Averaging to Buy Stocks Monthly

Are you planning to invest your entire life savings into the stock market all at once and never invest again? If so, it is understandable to feel nervous about high valuations and poor timing.

However, most people do not invest that way. Instead, most individuals invest a few hundred or thousand dollars into stocks every month on payday, year after year. This strategy is known as dollar-cost averaging.

Even if the stock market declines tomorrow, or drops 5% to 10% over the next few months, consistently investing the same $100 automatically from every paycheck allows you to purchase more shares at lower prices. Following a 5% to 10% sell-off, that same $100 investment buys 5% to 10% more stock than before. Though it sounds counterintuitive, it is true: stock market downturns can actually be “good news” for long-term investors.

The objective is to continue purchasing more shares of the stock market over time. As a long-term investor, you are likely to benefit from future growth in corporate earnings, dividends paid to shareholders, and share price accumulation.

I do not know what will happen to the stock market or the economy tomorrow, next month, or next year. Perhaps concerns about the CAPE ratio are valid, and the S&P 500 is overpriced and due for a correction. However, I believe that over the next decade (and beyond), my investments in a diversified portfolio of low-cost index funds will pay off. That is why I continue to buy stocks every month on payday.

Ben Gran has positions in Vanguard Morningstar Total Stock Market ETF. The Motley Fool has positions in and recommends Vanguard S&P 500 ETF. The Motley Fool has a disclosure policy.

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