Should You Buy Index Funds Now, in an Overvalued Market?

Summary

This video discusses the high valuation of the stock market, currently reflected in a Shiller PE ratio of around 35, which is double the historical average. It explores the dilemma for passive investors, referencing Jack Bogle's philosophy on the importance of long-term, consistent investing despite market fluctuations. The video emphasizes the historical success of dollar-cost averaging into low-cost index funds and the pitfalls of trying to time the market, advocating for a steadfast investment strategy based on fundamentals rather than speculation.

Takeaways

• 📈 The current Shiller PE ratio is around 35, which is double the historical average, indicating an expensive stock market.
• 🔍 In 2009, investors were willing to pay only 14 times the earnings, compared to the current 35 times, showing a significant increase in market valuation.
• 🤔 The historical average may not apply to modern times, but a Shiller PE of 35 is still the third highest in history, suggesting potential risks.
• 💡 Jack Bogle, the founder of Vanguard and known as the grandfather of passive investing, advocated for simply tracking the market throughout his life.
• 🗣 In a 1997 speech, Bogle addressed investing during an overvalued market, emphasizing that fundamentals should drive returns over speculation.
• 🚀 The 'Magnificent 7' tech companies have risen to high valuations based on future promises that may or may not be realized.
• 🔮 Two possible outcomes are presented: a significant market drop to normalize PE ratios or a new era of high valuations justified by exceptional stock returns.
• 🙅‍♂️ Bogle's advice is to not attempt to time the market, as no one has been consistently successful in doing so.
• 💰 The dollar-cost averaging strategy, used by passive investors, inherently protects against high prices by buying more shares when prices are low and fewer when they are high.
• 📉 Despite the discomfort of investing when the market is high, the long-term benefits of consistent investing in low-cost index funds have proven successful historically.
• 📝 It's crucial for investors to establish a clear, achievable plan that accounts for their financial situation, risk tolerance, and investment horizon.

Q & A

What is the current Shiller PE ratio mentioned in the script, and what does it indicate about the stock market?

The current Shiller PE ratio mentioned is around 35, which is roughly double the historical average. It indicates that investors are willing to pay 35 times the earnings of the stock market to own it, suggesting that the market is quite expensive compared to historical standards.

What is the historical average Shiller PE ratio, and how does it compare to the current ratio?

The historical average Shiller PE ratio is about half of the current ratio, which is around 35. This comparison shows that the stock market is significantly more expensive now than it has been on average in the past.

What was the Shiller PE ratio during the 2009 financial crisis, and how does it reflect investor sentiment at that time?

During the 2009 financial crisis, the Shiller PE ratio was around 14, reflecting that investors were much more cautious and only willing to pay 14 times the earnings of the stock market, compared to the current ratio of 35.

Who is Jack Bogle, and why is he considered the grandfather of passive investing?

Jack Bogle is the founder of the Vanguard Group and is known as the grandfather of passive investing because of his advocacy for tracking the market through low-cost index funds. His approach has contributed significantly to wealth generation worldwide.

What was Jack Bogle's advice on investing during an overvalued market in his 1997 speech?

In his 1997 speech, Jack Bogle advised that in the long run, fundamentals drive returns, not speculation. He highlighted the importance of focusing on dividend yields and earnings growth rather than betting on higher valuations.

What are the two extreme possibilities Jack Bogle mentioned regarding the market's future performance?

The two extreme possibilities mentioned by Jack Bogle are a market drop of 30-50%, which would lower the price-earnings ratio to a more normal level, and a new era where stock returns average 15%, justifying today's price levels with high valuations.

What is the main reason why investors should not try to time the market according to Jack Bogle?

Jack Bogle stated that no one has ever been successful in timing the market, and he does not know anyone who knows anyone who has been successful at it. This suggests that trying to time the market is a futile endeavor.

What is the significance of dollar-cost averaging in a passive investing strategy?

Dollar-cost averaging is significant in a passive investing strategy because it allows investors to buy a fixed dollar amount of shares at regular intervals, regardless of market conditions. This approach naturally leads to buying more shares when prices are low and fewer when prices are high, reducing the impact of market volatility.

What is the average annual return of the S&P 500 since 1957, and why is it considered a strong long-term return?

The average annual return of the S&P 500 since 1957 is 10%. This is considered a strong long-term return because it significantly outperforms other traditional investments like savings accounts, gold, or bonds.

What is the key to successfully implementing a passive investing strategy over the long term?

The key to successfully implementing a passive investing strategy over the long term is to set up a plan that works specifically for the individual investor. This includes determining a comfortable savings rate, an achievable investing schedule, and a mental commitment to the long-term strategy without being tempted to make adjustments.

Why is it important for passive investors to have a plan that accounts for their personal circumstances?

It's important for passive investors to have a personal plan because it helps ensure that they invest amounts they can afford without having to sell during market downturns. The plan should consider factors like the investor's time horizon, resources, income needs, and risk tolerance to ensure the strategy is sustainable and stress-free.

Outlines

00:00

📈 Stock Market Valuation and the Impact of AI Hype

The script discusses the high valuation of the stock market, driven by the hype around AI, and compares current Shiller PE ratios to historical averages. It points out the difference in investor sentiment between 2009 and now, highlighting the risks of high market valuations similar to those before the 1999 and 2021 market downturns. The video aims to explore the strategy for passive investors in such an overvalued market, introducing Jack Bogle, the founder of Vanguard Group, as a proponent of long-term, fundamental investing. The script also contrasts the current speculative market with the historical importance of fundamentals in driving returns.

05:03

🚫 Avoiding Market Timing and the Wisdom of Consistent Investing

This paragraph emphasizes the futility of trying to time the market, citing Jack Bogle's view that no one has been successful at it. It advocates for sticking to a passive investing strategy regardless of market conditions, using the example of a study showing that those who tried to time the market earned significantly less than those who invested consistently. The paragraph also touches on the importance of a long-term approach, owning the entire market through index funds, and the benefits of dollar-cost averaging, which naturally buys more shares when prices are low and fewer when they are high.

10:04

💼 Creating a Sustainable Investment Plan for Long-Term Success

The final paragraph focuses on the importance of establishing a personalized and sustainable investment plan to implement a passive investing strategy effectively. It stresses the need to understand one's financial capacity, investment timeline, and risk tolerance. The speaker advises against making hasty decisions based on market fluctuations and encourages sticking to a plan that accounts for personal circumstances. The paragraph concludes by reiterating the importance of investing consistently and not being swayed by short-term market volatility.

Keywords

💡Shiller PE

The Shiller Price-to-Earnings ratio (Shiller PE) is a valuation measure calculated by dividing the current stock market index level by the average of the past ten years' earnings of the companies in the index. In the video, it is mentioned that the Shiller PE is around 35, which is double the historical average, indicating that the market is currently overvalued compared to its earnings.

💡Growth Investor

A growth investor is someone who seeks stocks of companies that are expected to grow at an above-average rate compared to the market. The video discusses how the perspective of a growth investor might differ from a value investor when assessing whether the stock market is expensive or not.

💡Value Investor

A value investor looks for stocks that appear to be trading for less than their intrinsic value. The video script implies that value investors might be more concerned about the high Shiller PE ratio, suggesting the market is overvalued from their perspective.

💡Jack Bogle

Jack Bogle is known as the 'grandfather of passive investing' and the founder of the Vanguard Group. He is highlighted in the video for his advocacy of simply tracking the market, and his insights from a 1997 speech are used to draw parallels with current market conditions.

💡Passive Investing

Passive investing is an investment strategy that involves tracking the market by investing in low-cost index funds rather than attempting to outperform the market through active stock picking. The video emphasizes Jack Bogle's support for this approach and discusses its effectiveness.

💡Speculation

Speculation in the context of the video refers to investing based on the expectation of higher valuations rather than on the fundamentals of a company. It is suggested that speculation is currently driving stock returns more than investment based on fundamentals.

💡Fundamentals

In investing, fundamentals refer to the basic quantitative and qualitative information about a company or the economy, such as earnings, revenue, and growth potential. The video script notes that historically, fundamentals have been the long-term drivers of stock returns, contrasting with the current speculative nature of the market.

💡Dollar Cost Averaging

Dollar cost averaging (DCA) is an investment strategy where a fixed amount of money is invested at regular intervals, regardless of the price of the shares. The video explains that DCA has an inbuilt mechanism that helps protect investors from buying at high prices by naturally buying more shares when prices are low and fewer when they are high.

💡Asset Allocation

Asset allocation is the process of dividing investment funds among different asset classes such as stocks, bonds, and cash. The video script mentions that having an appropriate asset allocation is crucial for passive investors to ensure they can ride out market fluctuations without being forced to sell.

💡Market Timing

Market timing involves making investment decisions based on predictions of short-term market movements. The video cites Jack Bogle's view that no one has been successful at consistently timing the market, advising against deviating from a passive investment strategy based on market conditions.

💡Investment Plan

An investment plan outlines an individual's strategy for investing, including how much to invest, how often, and for what purpose. The video emphasizes the importance of having a clear, personalized plan to ensure the successful implementation of a passive investment strategy over the long term.

Highlights

The current Shiller PE ratio is around 35, roughly double the historical average, indicating a potentially overvalued stock market.

Investors are currently willing to pay 35 times the earnings of the stock market, compared to 14 times in 2009 post-GFC.

Despite arguments that historical averages may not apply to modern times, a Shiller PE of 35 is the third highest in history, after 2021 and 1999.

Jack Bogle, founder of Vanguard and known as the grandfather of passive investing, advocated for tracking the market throughout his life.

Bogle's 1997 speech on investing during overvalued markets is eerily relevant to today's conditions, emphasizing the risk of speculation over fundamentals.

The Magnificent 7 companies have risen to high valuations based on future promises that may not materialize, contrasting with Bogle's fundamentals-focused approach.

Bogle suggests two outcomes: a significant market drop to normalize PE ratios or a new era of high valuations justified by exceptional stock returns.

Investors face a dilemma between continuing to invest in an overvalued market or pausing until valuations normalize.

Bogle's advice against market timing is underscored by the lack of success among those who attempt it.

Dollar-cost averaging (DCA) is a passive investing strategy that mitigates the impact of market highs and lows by investing fixed amounts at regular intervals.

The S&P 500 has historically provided an average annual return of 10% since 1957, illustrating the benefits of long-term passive investing.

Bogle emphasizes the importance of owning the entire market through index funds and holding them indefinitely, regardless of market fluctuations.

Investors should not alter their passive investing strategy based on market conditions; consistency is key to long-term success.

Studies show that investors who frequently adjust their portfolios tend to underperform the market.

Bogle stresses the importance of having a clear, achievable investment plan that considers personal financial goals and risk tolerance.

An investment plan should include a defined savings rate, investment frequency, and a long-term commitment to avoid emotional decision-making.

Bogle's philosophy of 'buy and hold forever' requires an initial correct investment with an appropriate asset allocation suited to individual circumstances.

Passive investors should focus on setting aside money they won't need for decades and resist the urge to adjust their portfolio based on short-term market movements.

Transcripts

so it's no secret that on the back of

the Magnificent 7 all this hype around

AI the stock market has gotten pretty

darn expensive now of course we can

argue that point depending on whether

you're a growth investor or a value

investor but just objectively we're

currently staring down the barrel of a

Shiller PE of around 35 and that's

roughly double what the historical

average is and what that means is that

investors right now who are buying into

the market are willing to pay 35 times

the earnings of the stock market just to

own it if you rewind back to 2009 for

example after the GFC in investors that

were scared out of their wits were only

willing to Fork out 14 times the

earnings now there's probably an

argument to be made that the historical

average doesn't quite apply to modern

times but still having a look at the

shilli here it seems reasonably obvious

that 35 is still pretty high in fact

it's the third highest point in history

behind 2021 and 1999 and we all know

what happened in both of those occasions

but this begs the question if you're a

passive investor that being someone who

just buys index

what do you do is it a wise idea to

still be putting lots of money into the

market when it's clearly quite high is

it better to reduce the amount of money

you're regularly investing or even stop

until the market and the shil normalizes

a little bit well that's what I want to

cover in this video and to help answer

those questions I want to introduce this

guy he is the grandfather of passive

investing Mr Jack Bogle and the reason

why you might know him is because he is

the founder of the Vanguard group it's

kind of sad when we talk about great

investors of history we talk about Ben

Graham and Warren Buffett and Charlie

Munger and so on but Jack Bogle really

gets a mention however truth be told he

is probably responsible for more wealth

generation around the world than any

other investor he sadly passed away in

2019 but all throughout his life he was

a huge Ambassador for simply tracking

the market and what's interesting is

back in 1997 as the stock market was

forming into one of its biggest ever

bubbles Jack actually gave a speech on

investing during overvalued market and

to be honest it's kind of crazy how well

that lines up to today's conditions in

short it seems to me that speculation

betting on higher and higher valuations

is in the driver's seat investment

betting on the fundamentals of dividend

yields and earnings growth is in the

back seat probably even in the rumble

seat but when speculation drives stock

returns in the short run while it drives

stocks returns in the short run it's the

crystal clear lesson of history at least

for the past 200 years that in the long

run fundamentals Drive returns and just

like he was saying in the runup to the

tech bubble we too face the situation

today where a lot of the stock returns

we're seeing are based on speculation as

opposed to fundamentals I mean we've

seen the Magnificent 7 rise to

incredible valuations based on a future

promise that we're unsure will eventuate

we're seeing meta and Google at a PE of

27 Apple at 29 Microsoft at 37 Tesla at

45 Amazon at 50 and Nvidia at 62 but as

Jack notes in the long run it's always

the fundamentals that drive returns so

that leaves us with two possible

outcomes a world where AI lives up to

the hype and earnings rise to justify

the new valuations or a situation where

AI fails to deliver in which these big

stocks that support the market get

repriced and funnily enough that's

basically the exact point Jack talks

about in this next clip so that tension

has to be resolved let me give you two

extreme possibilities one a market drop

of 30 5% this would lower price earnings

ratio to a more nor ratios to a more

Norm normal level of about 13 times this

is hardly a doomsday scenario two we're

in a new era in which stock returns

average 15% in short a new era of Boom

times and high valuations that would

justify today's price levels now of

course it could happen but I wouldn't

bet the ranch on it the US Stock Market

however seems to be betting the ranch on

it it's priced I think for the best of

times and only for the best of times is

this speech actually from 1997 it's

actually a little bit scary how well all

of that lines up to what we see today

and I think many investors would agree

with Jack's statement today the stock

market is pricing in the best of times

and only the best of times and while The

Best of Times May eventuate Jack

certainly wouldn't go betting the ranch

on it but with that said that obviously

makes it a lot harder psychologically to

put money into the market right now

right for example I am in part a passive

investor and in part an active investor

but when it comes time to add more money

into my chosen ETFs on my dollar cost

averaging plan I always have this

Grimace when the market is at all-time

highs there's just something about it it

just doesn't feel great sinking a lot of

money into your long-term Investments

when you kind of know in the back of

your mind that the market is pretty

expensive it's kind of like paying full

price for a bit of furniture a few weeks

before Black Friday you feel bad paying

full price knowing a sale will like come

along in the not too distant future so

with that setup that leads us to the

question should we actually be buying

our Market tracking ETFs when the market

is at all-time highs should we try and

time the market just a little bit in

this case well this is what Jack had to

say all the way back in 2001 I don't

know anybody who has ever been

successful in uh timing the market and I

don't even know anybody who knows

anybody who has ever been successful in

timing the market so if you want the

short answer no you should not at all

deviate from your passive investing

strategy just because market conditions

have changed in the same way that you

wouldn't sell your Investments if all of

a sudden the market fell 30% tomorrow as

Buffett would say our favorite holding

period is forever the more you start

messing around with your Market tracking

Investments the higher the probability

that you'll lose that's quite literal a

study way back in 2000 studied 664652700

earned an annual return of 11.4% while

the market returned

17.9% annually the truth of the matter

is if you start messing around with your

portfolio you will likely lose out last

month on Le Riser you summed up your uh

investment philosophy is buy everything

and hold it forever do you still

subscribe to that uh in in light of what

the market has been doing or would you

unload some things now no I I my my

theory is is not subject to the ups and

downs the um paginations of the stock

the unpredictable paginations of the

stock market it's painful to do but I

think the idea of owning the stock

market is the best approach to equity

investing and perhaps I didn't make that

thoroughly clear there and while Jack is

of course a little bit biased on the

topic he's not wrong the idea of dollar

cost averaging into lowcost index funds

that track say the S&P 500 and then

consistently buying them and holding

them over a long period of time and

never selling has proven to be an

exceptionally successful strategy over

recent history I mean since 1957 which

is the year that the S&P 500 adopted its

500 stock structure well that index has

returned an average of 10% per anom

that's a phenomenal long-term return

considering what you might get elsewhere

in say savings accounts gold or bonds

and I will say despite it feeling

painful to buy the market when it's

visibly High remember there is actually

an inbuilt mechanism into the dollar

cost averaging strategy that protects

investors against really high pric

prices remember the dollar cost

averaging strategy which is the approach

implemented by almost all passive

investors is the process of buying a

fixed dollar amount of shares in a

lowcost market tracking index fund and

then repeating that purchase at fixed

time intervals over the course of your

investing career for example you might

choose to invest $1,000 every 3 months

and as the quarters go by you just keep

showing up well as I said this has an

inbuilt mechanism to protect you when

the market is high say the market

crashes and the ETF shares you're

looking at buying are now $100 each well

in that case with your $1,000 you'll buy

10 shares but then what if the market

goes on a rampage and the ETF Shares are

soon worth $200 well guess what now that

the market is expensive you're only

going to buy five shares when the market

is high the strategy keeps your buying

low and when it's cheap you're naturally

going to load up the truck it's genius

so not at high prices you should not

abandon your tried andrue passive

investing strategy it's much more

important to stay in the habit of

constantly investing just showing up

Rain hail or shine if you are not a

speculative investor if you're a

longterm investor and yet there are

these speculative investors buffeting

your returns about what should your

reaction be should be you be doing

anything differently I think basically

you should not be doing anything

differently I mean investment is a

pretty simple thing investment is owning

businesses or I would say being an

inveterate Index Fund person owning all

of American Business owning every

company in America letting capitalism do

its work uh those companies will grow at

probably around 7% a year they'll pay

you about a 2 and a half somewhat lower

than history but a 2 and a half%

dividend yield and that should over time

bail you out of anything that happens

because of the wild swings I mean if you

visualize investment as growing in kind

of a steady line which it does and

visualize the crazy Market as being all

these Jags up and down around this

steady line upward upward all always

upward I think then you've got to say I

know I'm not smart enough to get out the

high I know I'm not smart enough to get

back in at the low so I'm just going to

stay the course as we would say at

Vanguard and hang on through all that

and importantly if I'm trying to

accumulate money for retirement or to

buy a home or to educate my children

what you want to do is keep investing

keep investing rain hail or shine

passive investors are better off if they

just keep going without messing with

their strategy but there is one key to

actually putting this Theory into

practice and this gets glossed over a

lot because it's not as glamorous is

showing a compounding chart or talking

about how soon you could be a

millionaire and the point is finding the

right plan for you while we know we buy

the market and we buy it consistently

it's really important that you actually

nail down your plan into hard numbers

what's your current savings rate what

percentage are you willing to devote to

investing how much money will that mean

that you save each fortnite how

frequently are you going to invest that

money how do you make sure you won't

fall off the train as Jack is about to

discuss you need to really nail down an

achievable plan for you to ensure you

can implement this strategy over the

long term for yourself but I think the

idea of buying and holding forever and

not trying to make adjustments requires

that you've gotten it right in the first

place you can only hold tight if you've

bought right if you will and that is to

say have an asset allocation that has

something to do with how how many years

you have to accumulate money how much

resources you have at stake how much

income you need and how much courage you

have to ride out the paragr naations of

the market so you've got to take all

that into account from that simple

statement and I know it sounds boring

but in my experience you really do have

to come up with a plan that works for

you specifically to be able to execute

the strategy successfully over a long

period of time as Jack spoke about in

the clip you have to understand how much

you can comfortably set aside for

investing without something coming up

that could force you to sell your

Investments you have to know how long

you plan to be in the market for example

you wouldn't be dumping large sums into

an overvalued Market if you looking to

retire in 2 years and then from there

you also have to know yourself how

comfortable are you having money at

stake if you're someone who frequently

stresses about your Investments and has

a tendency to make snap decisions then

maybe the stock market isn't for you

maybe you might prefer government bonds

or perhaps paying down your mortgage

instead a lot of times with passive

investing the investor is Their Own

Worst Enemy so I'm definitely big on set

setting up a plan that genuinely works

for you that isn't stressful to continue

with ultimately for this strategy to

work you need to set aside money that

you won't need to touch for decades you

need to invest often and you mustn't be

tempted into messing around with your

portfolio so you need to understand what

amount you can easily set aside what

investing schedule you can stick to and

you need to mentally commit to the

longterm to ensure you don't end up as

just another failed investor remember

that step from before the studies show

the more you mess around with your

Investments the more likely you are to

lose but if you're relatively young if

you are investing money that you don't

need and you're properly spread across

the market through something like a

market tracking Index Fund then you can

be reasonably confident as Jack says

that you've bought right so that's the

deal with index funds when the market is

at all-time highs now if you're

interested in getting the full breakdown

in a simple step-by-step manner

definitely check out stock market

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