“ The valuation test. Even if you invest only via broad index funds, you still must decide how much of your assets you want to hold in equities overall. In general, that should be determined by how much risk you want to take. But if you check some basic market statistics, you can easily see that stocks are more expensive at some times than they are at others. It seems like common sense to trim back when an asset class is dear, and hold a little extra when it’s cheap. Andrew Smithers, head of the London investment research firm Smithers & Co., argues that the 10-year price/ earnings ratio - sometimes known as the Shiller P/E, after the Yale economist - is one way to reliably gauge how expensive stocks are. It looks at what the market is willing to pay for stocks based on average earnings over the past decade in order to smooth out short-term bumps. When the long-term P/E is high, as you can see in the graphic below, future returns have tended to be low. (You can find this P/E at irrationalexuberance.com.)
Don’t try to time the market - Jan. 6, 2010
While I’ve never tried to time the market, instead relying on a passive investing approach, largely driven by putting money in index funds and thinking little of them for the year, I do think it makes sent to adjust the weighting of your portfolio if the market seems “expensive” or “cheap”.
2 years ago