I’m a fan of index funds. Within my retirement portfolio, I have both US and global index tracker products. But is it smart to put more money into these funds while the S&P 500 index is near all-time highs? Let’s discuss.
Averaging in
Experts often recommend drip-feeding money into index funds on a regular basis (eg monthly). And generally speaking, I think this is a smart strategy.
By putting money into the markets at regular intervals investors can average out their entry points over time. Some purchases will be at lower levels while some will be higher.
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The downside to buying high
That said, I’m always a little bit apprehensive about putting cash into index funds after the stock market has had a really strong run. Because the starting point can have a significant impact on overall returns in the following years.
Looking at the S&P 500 today, I wouldn’t be surprised if returns were a bit underwhelming in the short/medium term. Not only is the index up around 33% over the last year but valuations are very high. Currently, the average trailing price-to-earnings (P/E) ratio across the S&P 500 is about 24. Meanwhile, the top 10 stocks in the index have an average P/E ratio that’s even higher.
It’s worth noting that last month analysts at JP Morgan said that average calendar-year returns for the S&P 500 could shrink to below 6% in the next decade due to the strong recent performance. The basis for their argument was largely placed on valuations – current stock market valuations are high relative to history.
Looking for value
Now, this doesn’t mean I’m not going to be investing in the near term. It just means I’m going to focus on different investments.
What I tend to do when markets have had a strong run is reduce my index fund contributions and focus more on stocks and areas of the market that offer value. This way I can put money into assets that I believe have more return potential.
I’ve been buying this stock
One stock I’ve been buying for my retirement portfolio recently is Alphabet (NASDAQ: GOOG). It’s the owner of Google, YouTube, and self-driving car company Waymo.
This stock recently fell from $190 to $150 and I bagged a few more shares for my portfolio at a price of $154. At that share price there was some value on offer, to my mind.
Next year, Wall Street expects Alphabet to generate earnings per share of $8.71. So I bought the stock when it was trading on a forward-looking P/E ratio of just 17.7. That’s below the market average, and it’s an attractive price for this legendary tech stock, in my view.
Of course, there are no guarantees this move will pay off. Investing in individual stocks is riskier than investing in index funds. In this case, one risk to consider is scrutiny from regulators. Another is Google search being disrupted by ChatGPT.
I’ve bought this stock on the dips many times before however. And it’s always paid off as the company has continued to grow. So I’m optimistic that my recent purchases will generate attractive returns in the years ahead.
