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How Should an Overvalued Market Affect Your Investment Plan?

Even with the rough month we just had, people are still talking about how the market is “overvalued.” They could be right or wrong. No one in the entire world knows.

Markets don’t move capriciously. They move because something new has happened – new information has arisen. The market has already absorbed all currently available information, so until the situation changes (and it always is) prices won’t move.

The tricky part is that we don’t know what new information will arise. Until Marty McFly shows up at your door with an investor’s almanac from the future, we won’t know how those new events will differ from our expectations. For that reason, you need to manage to your financial plan and focus on harvesting long-term market returns.

How Do Market Valuations Fit In?

The financial markets are some of the most self-obsessed systems out there – possibly even more than celebrity gossip. Everyone is constantly tracking all sorts of different metrics. It’s no surprise when the markets end up with higher valuations than normal – they’re the result of well-observed market forces.

It can feel scary, but, based on all currently available information, the market considers these valuations to be appropriate. Everyone could see how the market arrived at the current valuations. There are no secrets in security prices. The valuations we are seeing are just how the market values the level of risk out there.

Now, tomorrow’s news could still bring everything crashing down, but that’s always been true. Everything is based on that next bit of information, but we don’t know if it will be better or worse than expected news

Holding off on investing to avoid high valuations is just as much market timing as pulling money out of the market because of those valuations. You’ll end up with the same set of challenges and pitfalls as any other attempt at market timing.

Manage to the Plan

Your goal should be to meet your financial objectives, not get the high score on your investments. Shooting for the high score means taking on more risk, most likely risk with a negative expected return. Market timing definitely carries negative expected returns.

Focus on harvesting long-term market returns that allow you to slowly but surely keep moving toward your financial goals. You can accomplish that by building a portfolio that will let you sleep at night, regardless of the ups and downs of the market. With such a portfolio, you can stay focused on the long term and remain disciplined.

Jumping in Can Be Hard

We’re human. It’s unnerving to dive in to the water when the majority of people are claiming it’s too cold right now. From a pure numbers standpoint, it’s easy to say you should ignore them and push forward, but investing isn’t just about the numbers (my job would be a lot easier if it was). Investing is about meeting your financial goals and having the discipline to stick it out long term.

A number of investors have overcome their fears of the market through dollar cost averaging. If you’ve never tried it, it’s worth looking into, as it can help you ease your way into the market and stay disciplined for the long term.

Whatever the market has done up to this point, we have no idea what it will do going forward. Valuations may be higher than normal, but that doesn’t mean the market has to go down. The market never “has to” do anything. Unless you’re a prophet, stay disciplined and invested.

To find out more about how to build an investment portfolio that works for you, read our eBook 9 Principles of Intelligent Investors.

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