The stock market is hitting record highs in 2024, with the S&P 500 reaching new peaks 24 times this year. Factors like expected interest rate cuts and the excitement around artificial intelligence (AI) are driving this growth. Nvidia, a leading AI stock, has played a major role, contributing significantly to the S&P 500’s gains. But as the market soars, investors need to be cautious. Here are two mistakes to avoid.
Mistake 1: Avoiding Stocks Out of Fear of a Market Correction
It’s natural to feel anxious when the stock market hits record highs. Some investors might think it’s best to stay out of the market to avoid potential losses if a correction happens. However, history shows that avoiding stocks because of fear can be a bad strategy.
Fidelity Wealth Management strategists have pointed out that the S&P 500 often performs well after reaching a new high. Since 1950, the S&P 500 has averaged a 12.7% return in the year following an all-time high. This is slightly better than the average 12.4% return in other 12-month periods. Moreover, in the past 50 years, investing in the S&P 500 at an all-time high would have resulted in a gain 70% of the time, with an average return of 9.4%.
Trying to time the market usually doesn’t work. Legendary investor Peter Lynch said it best: “Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.”
Mistake 2: Ignoring Valuations When Buying Stocks
On the flip side, getting carried away by the market’s momentum can also be dangerous. When the market is high, some investors become overconfident, thinking they can’t lose. This overconfidence can lead to ignoring stock valuations, which is risky.
Currently, the S&P 500 is trading at 20.3 times forward earnings, higher than the five-year average of 19.2 and the 10-year average of 17.8. This indicates that many stocks are expensive compared to historical standards. Ignoring these valuations can lead to poor investment decisions.
Warren Buffett, another legendary investor, warned against this in his 1982 letter to Berkshire Hathaway shareholders: “A too-high purchase price for the stock of an excellent company can undo the effects of a subsequent decade of favorable business developments.”
There are different ways to value a stock, from simple ratios to complex models like discounted cash flow. The key is to determine whether a stock is trading at a fair price. It’s wise to avoid stocks that are significantly overvalued compared to their historical price-to-sales or price-to-earnings ratios, unless there have been major changes in the company.
Bottom Line
The stock market’s recent highs can tempt investors to make hasty decisions, either by staying out of the market due to fear or by ignoring stock valuations. By understanding these common mistakes and focusing on long-term strategies, investors can better navigate the ups and downs of the market and make more informed decisions.
