5 questions to ask yourself when capital markets look expensive

A long time in this business, and a good memory, means that I have a lot of little sayings locked away in my head. Things like, “time in the market beats timing the market”, and “the biggest risk of all is not taking one”, and “price is what you pay, value is what you get”.

But sometimes these little sayings really capture the situation. Maybe we’re there today. Let me elaborate.

If you look out into the investment landscape, nothing is clear. Granted, it rarely is, but for example, at the time of writing this, the S&P 500 has doubled in less than 5 years, just 53 months. The Nasdaq 100 has almost doubled in just 2 years. Even the ASX 200 is up hard, just off all-time highs as I write this. Commonwealth Bank is the world’s most expensive bank and believe it or not, the ASX Technology index outperformed the Nasdaq 100 in 2024, and by twenty percentage points too.

Things are expensive. It makes me think of another classic saying – “the best time to have planted a tree was 20 years ago, and the second best time is today”.

Whilst valuations are high, in 20 years time, they’ll be higher, right? Right??

Consider that using historical data as the basis, the S&P 500 has a 28% chance of being down in a given year, about a 14% chance of being down over 5 years, about a 7% chance of being down over 10 years, and a near zero chance of being down over 15 years. Again, I’m not predicting that but historically, the longer your time span, the less likely it is that you’ll lose money.

So what is an investor to do? You’ve just moved to an SMSF, or you just sold an asset, or you inherited some cash – you don’t want to blow it, so what do you do? Here are five things to think about when making that investment decision, and maybe the point of this piece is to demonstrate that none of them are related to the saying you’re thinking of - about price and value – and have everything to do with the first two sayings at the top of this piece.

Again, nothing to do with price and value. I know.......radical.

To be clear, this is not intended as personal advice and should only be considered general in nature. Please read the disclaimer at the bottom of this piece in full before reading any further.

Now, those five things.

1. When do you need the money back?

Generally speaking, the longer you can invest the money for, the more risk you’re able to take. You don’t have to take that risk, but it technically opens the door. See the paragraph above about S&P 500 returns over time but think of it this way – there’s a good reason why next month’s rent money should be in cash, and your super should be in global shares.

2. How does my income compare to my expenses?

When you’re able to cover your day-to-day expenses with your current-and-recurring income, and you’re not going to call on your investable assets, it extends what I like to call your “risk runway”. That gives you the liberty to take more risk. More risk has historically meant better returns.

3. What else is in your balance sheet?

Don’t make investment decisions in isolation. You need to know and understand what else is in your balance sheet (a quick aside – if you’re working with a professional financial advisor, or you’re interviewing one, and they don’t ask you what else you own, run, at a million miles an hour). For example, if 65% of your balance sheet is commercial real estate, I don’t care how low the price is, you better have a really good reason for buying Centuria or Dexus or Charter Hall. Really good. Also consider that liquidity matters. If you do have all of that real estate already, a 7-year lock-up PE or VC fund is unlikely a great idea. Make your investments, along with your entire balance sheet, work together for you.

4. What are you trying to achieve?

If you’re trying to build a stream of passive income, the S&P 500 or the Nasdaq 100 is unlikely to help you – they’re growth engines with relatively low yields. That said, if you already have loads of income, don’t buy fully franked dividend paying Aussie shares – the income is exceptional but you don't need it, and Aussie shares struggle to grow.

5. Am I diversified?

Unless you have a very firm and well thought out plan, and most people do not, diversify across a variety of investments, regardless of your asset allocation. For example, if you want to be high growth, no problem – but diversify across several high growth ideas that are (hopefully) lowly correlated.

Remember, there are very rarely right or wrong answers in this business, only trade-offs.

And at the risk of talking my own book, if you’re not sure, hire a professional. If your car splutters, you see a mechanic. Same if your knee starts hurting, or your ski binding falls off. You don’t try and do those things yourself, and maybe, just maybe, this isn’t something you should do yourself either.

It's hard so if you’re not sure, it’s worth at least a meeting. Again, apologies for stumping for my industry.

Good luck out there.