How To Trade When Markets Hit All-time Highs

With the market near all-time highs, buying stocks can look like a worrisome proposition and it’s no surprise that many investors feel more comfortable sitting on the sidelines.

Staying out of the market entirely, though, presents an opportunity cost in the form of lost potential returns. So, just what can investors worried about the market’s performance and potential volatility do to limit their risks while still putting their money to work for them?

Key Points

• The stock market appears risky, with high valuations driven by tech stocks, AI hype, and economic uncertainties like tariffs and inflation.
• S&P 500 funds provide long-term growth, averaging 10.3% annual returns, with diversification and resilience through market volatility.
• Regular investing through DCA smooths costs, reduces timing risks, and, when combined with S&P funds, builds wealth steadily.

How Worrisome Is the Stock Market Right Now?

While it’s true that investing in stocks always carries risks, the market today looks particularly troublesome from a reward to risk standpoint.

In the wake of the 2020-21 era, stocks shot up at a meteoric pace. Much of this rise has been driven by enthusiasm for AI, causing mega-cap tech stocks to rocket higher and drag the broader market along with them. Indeed, the so-called Magnificent Seven companies now have a combined market cap of about $17 trillion.

Unsurprisingly, the aggressive tear that stocks have been on the last couple of years has left them looking quite expensive.

One useful metric used to gauge the value of the stock market as a whole is the ratio between the total market cap of all stocks and America’s GDP. This ratio, sometimes referred to as the Buffett Indicator because of Warren Buffett’s well-known affinity for it, is currently at 208 percent and strongly indicates that the stock market as a whole is likely overvalued.

Stacked on top of the problem of possible overvaluation are a number of potential stock market torpedos on the horizon. Donald Trump’s high tariff proposals, for instance, may very well impede trade and exert downward pressure on the economy. So too, the national debt continues to mushroom higher and creates greater risks of higher inflation.

S&P 500 Index Funds to the Rescue

The good news for investors is that there is a simple, proven instrument that has the potential to generate long-term returns through a variety of market conditions.

S&P 500 index funds track five hundred of the largest, most successful companies in the United States. As a result, these funds essentially allow investors to buy a cross-section of the American economy and profit as economic growth continues.

Index funds of this sort have been recommended by many famous investors, including some who made their careers trying to pick stocks that beat the S&P. Warren Buffett has famously arranged for his wife’s inheritance to be put into one of these funds when he dies. Billionaire hedge fund manager Ken Griffin, meanwhile, has an S&P 500 ETF as the largest holding in his firm’s broad portfolio.

When it comes to long-term returns, very few individual stocks can boast the kind of record the S&P as a whole can. Since 1957, the index has returned an average of about 10.3 percent.

Although the S&P has its ups and downs along with the rest of the stock market, its trajectory has been a long upward climb as America’s economy has grown and developed.

Because it includes many large, mature companies, the S&P also offers investors a decent stream of dividend income. At the moment, the overall index has a yield of about 1.2%, which is somewhat low by historical standards. Over time, dividends account for a significant portion of the index’s total return.

To illustrate just how powerful the compounding power of the S&P 500 is, consider what would have happened if you had invested just $1,000 into it 40 years ago.

With dividends reinvested, $1,000 invested in the S&P in November of 1984 would be worth over $83,000 today. At around 1.2%, that investment would also be able to generate almost $1,000 in dividend income annually.

Even without reinvesting the dividends, you would still end up with nearly $35,000 from price appreciation alone.

The key point to recognize here is that these returns have continued in spite of periods of overvaluation, economic downturns, wars and even massive financial shocks like the 2008 financial crisis and the extraordinarily unusual 2020 era.

As such, the S&P has historically been one of the best things to buy when stocks have looked risky as they do today.

The Power of Dollar-cost Averaging

If you’re looking to spread risk, perhaps the number one approach that most financial advisors would recommend is dollar-cost averaging (DCA).

The way it works is to invest a set amount of money on a recurring schedule regardless of price. For example, you may choose say once a month or once per pay period.

Using a dollar cost averaging strategy, buyers can average out their cost basis over time and avoid the pitfalls of overpaying when investing a large amount at once. The other side of the coin is you won’t ever buy the bottom of the market but equally you won’t buy the top.

No matter whether markets are rising or falling it makes it easy to add to a portfolio in a variety of market conditions, offsetting high prices at some times with lower prices at others.

Beyond its usefulness in smoothing out volatility, it’s a pretty good way to build the habit of contributing regularly to a portfolio without taking into account the day-to-day swings of the market. Over time, this regular and disciplined approach to investing can produce some extraordinary results.

Combining DCA With S&P 500 Index Investing

When combined, dollar-cost averaging and passive index investing can provide a high degree of diversification. Buying an index of 500 large, successful companies helps investors protect themselves from the ups and downs of any one stock.

Meanwhile, investing at regular intervals provides some protection from volatility and limits the chances that an investor will significantly overpay.

To show the combined power of these strategies, let’s return to the example provided earlier of investing $1,000 in 1984 and allowing it to grow for 40 years. That single investment alone would have turned into well over $80,000.

Now, imagine what would happen if $1,000 were invested in the same fund every year. Over time, this incredibly simple and largely passive approach to investing would lead to significant wealth.

While this kind of investing doesn’t provide the potential to beat the market over time like concentrated value investing does, it’s also a vastly easier way to manage money that carries less risk. For many investors, therefore, buying an S&P 500 index fund while employing DCA is the simplest and most effective way to gradually build wealth. Employing this strategy today may help investors succeed over the long run despite the risks that are present in the market at the moment.