Apr. 26, 2015 2:10 AM ET
Summary
- The big news of 2015 so far has been the so-called “earnings recession".
- Understanding the market is as much about human behavior as the available financial data.
- Focus on keeping well informed, use that information to make sensible decisions.
With the disclosure out of the way, let's look at how to best answer the question in a sober frame of mind. Firstly, in times when the stock market starts looking a little frothy, people turn to famed investor Warren Buffett to see what he has to say. In late 2014, onlookers were noting that the Sage of Omaha's "one best measure" to value bubbles (being a simple cross comparison between the stock market and GDP growth) was well above where it should be, pointing to a stock market bubble.
Six months on in April 2015, however, and the same man gave an interview to CNBC. There, he told the interviewer that a bubble was quite some way off yet. However, he did note that there was very little cheap in the market right now. Basically, he's saying that the market isn't at nosebleed-inducing measures but that it's not quite at normal levels, either.
It would be a brave or stupid investor that would bet against the (usually) wise words of Buffett. We're not about to, either. Well, with a caveat. When there's not much cheap in the market, it means that it's approaching bubble levels. Remember the phrase, "be fearful when others are greedy and greedy when others are fearful"? Right now, there are more greedy investors out there than fearful ones. If we take his "not much cheap" comment to refer to non-tech stocks only, and accept that tech stocks certainly aren't cheap in 2015 - then one thing is certain: there's very little value to be had in the market at the moment. Therefore, betting on anything going up by much more doesn't look wise.
All that said, with so many tools currently available to investors (CFDs, options, etc.), the question is perhaps a little too all-or-nothing. There's no need to make one-way bets on the market when you're leaving yourself prone to the whims of so many traders and investors.
Hindsight tells us that if you're already reading articles about bubbles, then it's time to tread very carefully in the stock market. The truth is that it's less relevant exactly when the next burst bubble arrives as long as you've taken out sensible positions in your trades. From there, you should be fine, regardless of what day the next burst bubble falls on.
How much should I invest?
Anyone looking to answer the above question should be commended. It's always a valid question to ask, regardless of the type of investment. It shows a degree of responsibility not always evident among more seasoned investors. Generally, we would recommend anyone asking themselves the question to see the advise of a peer-reviewed financial advisor. This is not an expense that should be scrimped on, either. Good financial advice will be worth it further down the road, while bad advice will come back to haunt you. Besides, the payment made to the advisor can effectively be written off over the lifetime of the investments they advise you to make.
The truth is that everyone should invest the majority of their discretionary income in one form or another. This can be in education, the family home or other more orthodox investments such as stocks and treasuries. This isn't as outlandish a suggestion as it may first appear. Most people just leave money in a traditional savings account. That's generally fine but unless it's in a long-term savings account providing 5% per year, the reality is your money is loosing value over the long term. So much for the safety that a bank account provides you.
Accepting that you should invest most of your money is the first step. The next question becomes: "what are my cash needs?" That is - what's your need for liquidity? Treasury bonds are considered as liquid as any investment (meaning you can cash out almost on demand).
Likewise for the best corporate debt. Most stocks are pretty liquid too. But consider real estate - sure, a well-chosen piece of land or property will pay for itself over time, but how easy will it be to cash out in a day or two if your requirement for fast cash calls for that? Nigh on impossible.
Next, your time profile should be taken into account. Most investments are made with a five-year timeframe in mind at the minimum but it varies. Young, forward-thinking individuals will often take on thirty year investments (a mortgage or college savings fund for their children being prime examples) while older people will tend to take on investments with shorter timeframes (unless they're trying to build a legacy or make investments on their children's and grandchildren's behalf). You can see the logic here: the timeframe will be specific to you but it is an important decision.
Finally, the question, "how much money should I invest?" is best answered by, "it depends - how risky are the investments you're talking about?" This is the closest to a black and white answer you'll get here: you should never, ever bet the house - regardless of how safe the investment seems. Even the American government, home of the "risk free" bond, has gone bankrupt four times. Make sure you're well aware of the investments' risk profiles. We're not saying to avoid higher risk growth shares (to take one example), but be aware that with higher return, comes higher risk.
By definition, the compound growth provided by good investments makes beginning to invest today better than doing it five years down the line. Likewise, the more you invest, the more that compound growth makes an impact. But be prudent. The advice we've given here is a primer at best and should be treated as such. Even the greatest investors hire their advisors and you shouldn't be any different.
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