Market Tops: Should You Avoid Investing at All-Time Highs?

“Buy low, sell high.”

As it turns out, this advice may not be as good as you think.

Failing to invest at all-time highs can cause you to miss out on years of compounding by keeping you stuck on the sidelines and waiting for a pullback that never comes.

Furthermore, and a bit counterintuitively, investing at all-time highs may even be more profitable than investing on any other given day.

Here's everything you need to know about investing at market tops, and why you shouldn't fear investing at all-time highs.

The data and concepts in this article pertain to investing in the S&P 500 index, not individual stocks.

The market regularly hits all-time highs

After peaking on January 3, 2022, the market fell by -25.4% in a drawdown that lasted a little over two years:

Source: Koyfin

Many investors, expecting the market to go even lower, stayed on the sidelines and watched as the market clawed its way back from the low.

By January 2024, with the market back at all-time highs, these investors thought the opportunity to buy had passed completely.

However, after ending the bear market by setting a new high on January 19, 2024, the S&P is up an additional +20.64% (as of October 22, 2024):

Source: Koyfin

A bear market turned into all-time highs, which turned into more all-time highs. How common is this behavior?

Very common.

Here's a table showing the 1-, 3-, 5-, and 10-year returns from new highs following a bear market:

Source: A Wealth of Common Sense

In almost every instance, new all-time highs after bear markets were followed by more all-time highs. The average 1-, 3-, 5-, and 10-year total returns following new highs are +16%, +27%, +59%, and +206%, respectively.

Since 1950, the S&P has charted over 1,450 new record highs, roughly 6.5% of trading days:

Source: Savant Wealth

Notice the clustering — new highs tend to occur consecutively and persistently. In other words, all-time highs tend to be followed by more all-time highs.

Given that companies are growing and becoming more profitable over time, this is exactly what we should expect from a healthy market. You should expect to see many new highs over your investing life cycle.

But what does this mean for returns? Is it a bad time to invest when markets are at new highs?

What are the returns when investing at all-time highs?

It turns out, average returns are better when investing at all-time highs.

Check out this chart from JP Morgan:

Source: JP Morgan

If you had invested in the S&P 500 on any given day between January 1988 and August 2020, your average total return a year later would have been +11.7%.

But, if you had only invested on the days when the S&P 500 closed at an all-time high, then your average total return after one year would have been +14.6%.

This trend holds true for 3-year returns (+39.1% vs +50.4%) and 5-year returns (+71.4% vs +78.9%).

If you're wondering how this is mathematically possible, it's because only investing on days that close at all-time highs causes you to miss many of the worst-performing days.

Why is investing at all-time highs so difficult?

This above data is completely counterintuitive.

Don't all-time highs signify the market has never been more expensive? Don't all-time highs mean we're due for a pullback? How can returns possibly be better when the market is at its highest?

One explanation for why returns are better from all-time highs is because of investor behavior.

• Anchoring: We anchor to old prices. The S&P can't be worth $5,800 because it was only worth $4,200 a year ago. For this reason, most investors have a hard time buying at all-time highs, even when the underlying fundamentals support it.
• Loss aversion: We hold onto losing stocks for too long, hoping they'll come back to our purchase price so we can sell them without losing money. On the flip side, we're quick to sell our winners and lock in profits.
• Value seeking: We always want to feel like we're getting a good deal — nobody wants to buy anything when it's at its highest price ever. Plus, oftentimes, we could have bought at a lower price and didn't, which makes buying today even more difficult.
• Fear of big losses: Investing at all-time highs exposes us to the possibility of earning the lowest possible returns.
  

All of these cognitive biases work together to create a psychological barrier that keeps stock prices lower than fair market value when the market is at all-time highs.

In turn, this leads markets to slowly but continuously make new highs as more and more investors buy their way back into the market.

Should you worry about timing the market?

Additional data suggests that the question you're asking — “Should I invest when markets are at all-time highs?” (which is really a question about market timing) — is largely irrelevant.

Historically speaking, the difference between investing on the worst possible days (the highest point of each year) vs the best possible days (the lowest point of each year) isn't as significant as you might think.

Here's a chart that shows the difference in returns between perfect timing and the worst timing for the S&P between January 2000 and June 2023:

Source: Plante & Moran

Yes, although achieving the impossible task of investing at the best possible time each year does result in higher returns, the difference isn't that staggering.

And even if you had the incredibly unfortunate luck to invest on the worst possible day every year for 23 consecutive years, you still would have outperformed 3-month Treasuries by nearly 3x.

Still, buying at an all-time high exposes you to the possibility of buying at the very top. If this is a concern, it's useful to learn how rare market corrections from new highs have been.

How frequent are market corrections following all-time highs?

The charts below show how frequently the S&P 500 Index has been down 10% or more over various time periods following each of the 1,250+ all-time highs since 1950:

Source: RBC

Conclusions

• 1 year after reaching an all-time high, the S&P has been down 10% or more only 9% of the time.
• 3 years after reaching an all-time high, the S&P has been down 10% or more only 2% of the time.
• 5 years after reaching an all-time high, the S&P has never been down 10% or more.

Compared to the frequency of new highs, long-lasting market corrections are extremely rare.

The final word

Hopefully, this article has made you more comfortable with the idea of investing when the stock market is at or near all-time highs.

The data clearly shows all-time highs are common and are frequently followed by periods of strong performance and more record highs.

If you're a long-term investor, you should expect to see many new highs over the course of your lifetime.

A handful of them will precede market crashes, but most of them will probably lead to more highs.