We are almost hallway through 2014, and the stock market has continued its climb since the lows hit in 2009. The S&P 500 index has returned an average 18.4% a year over the past five years, as of May 31, 2014. The index’s average return over the last 10 years has been more modest, but still respectable, at 7.8%.
Unfortunately, investors have not reaped the benefits of stock market gains like they have in the past. The chart below shows that investors as a whole only held 37% of their savings in stocks as of the end of 2012. This was much lower than in previous periods.
One theory to explain the drop is that investors have become disillusioned after experiencing two significant stock market drops in the last 15 years – first with the technology crash between 2000-2002,
and then later during the financial crisis between 2008-2009.
Making each drop more painful, you can see that the portion investors held in stocks was significantly higher preceding each drop, and lower with each recovery. After getting burned twice, investors seem more conservative now than they were in the past – during a period stocks have performed well.
There are other theories on what contributed to the drop in stock ownership, such as increased interest in alternative investments, as well as an aging population shifting into bonds as they approach retirement.
When is the right time to buy stocks? It depends on you.
When deciding how much to invest in the stock market, it’s tempting to make the decision based on recent market performance. Some people want to increase their investments in stocks because they are attracted to the strong gains of the past few years; while others see the new market highs as reason to be more cautious.
The better way to approach investment decisions like this is to focus on factors within your control – such as how many years you have left until retirement and your risk tolerance. For example, if you have 5 years or 20 years until retirement - this is much more important than expectations about how stocks will perform next year.
By making decisions based on factors within your control, you will be less likely to suffer the consequences of poor market timing (similar to the swings in the chart above). Sticking to a good plan during difficult periods increases your chances for long term success.