The S&P 500 is on a roll. Not only is the index up close to 17% this year, but it has also risen in each of the last four months.
For some investors, this momentum could be attractive. Others, though, might be nervous that the joyride could screech to a halt. Should you buy stocks now or wait for a pullback?
Image source: Getty Images.
The case for waiting
Let's first look at why you might want to wait for a pullback before buying stocks. One argument is that the market is due for a pullback after its recent gains, and you'd ideally want to buy in at lower prices.
There is some historical support for the view that the markets are due to drop. As the chart below shows, the S&P 500 tends to experience a down month after several consecutive months of increases.
S&P 500 Monthly Return data by YCharts
There's more to the story, too. September has historically been the worst month of the year for the S&P 500 by far. Since 1945, the average return for the index has been negative in only two months of the year -- February and September. However, the average decline in September has been three times greater than the average decline in February. History doesn't predict the future, but it's worth thinking about.
Perhaps the best argument for waiting to buy stocks, though, is valuation. The S&P 500 currently trades near its second-highest level ever based on the Shiller cyclically adjusted price-to-earnings (CAPE) ratio. Historically, periods of below-average returns have frequently followed when the CAPE ratio reached high levels, meaning if things play out like one might expect, stocks could be dropping soon.
S&P 500 Shiller CAPE Ratio data by YCharts
It's not surprising that Warren Buffett has more of Berkshire Hathaway's money in cash and short-term investments than at any time in the past. He prefers to be more heavily invested in stocks, but he only buys stocks when their valuations are attractive, and maybe's he's expecting a pullback and wants to be ready for it.
The case for buying stocks now
But before you firmly decide to stay on the sidelines, it's important to consider the case for buying stocks now. And there are some quite strong arguments for doing so.
First, history isn't all that great of a guide. Just because September has been a bad month for the S&P 500 historically doesn't mean that the index will always decline in September. Also, the average decline for the index in September is only 0.6% -- not exactly a huge sell-off.
Second, it's almost always futile to try to time the market. Sure, you might get lucky every now and then. However, Buffett once said, "Market timing is both impossible and stupid." When one of the greatest investors of all time has that to say about trying to time the market, it's worth paying attention.
Third, investing in the S&P 500 has always paid off over the long term. You could have bought at the seemingly worst times in history (for example, right before the dot-com bubble burst or before the 2008 market meltdown) and still been a big winner if you held long enough.
Try both options
Should you buy stocks now or wait for a pullback? The best strategy could be to combine both by using dollar-cost averaging. With this approach, you invest equal amounts on a regular basis, so you're not putting all your available cash into the market right now but you're not avoiding buying stocks altogether. With dollar-cost averaging, you'll buy high at times and low at others, and, over the long run, you'll likely reap solid returns.
Of course, where you invest matters tremendously. Some stocks aren't good long-term picks. Maybe their underlying business isn't strong. Perhaps their growth prospects don't justify their high valuations.
If you're buying individual stocks, do your homework. If you want an easy alternative to selecting individual stocks, invest regularly in a low-cost S&P 500 index fund that owns shares of all the companies in the index. Either way, the longer you're in the market, the higher your chances of winning.
