Share prices look pretty expensive at the moment

Last week a fund manager told me that he was struggling to find anything to buy. There are plenty of companies out there that he likes, but the share prices are too high. Nothing looks cheap.

I think my fund manager friend is right – shares do seem expensive. The FTSE 100 isn’t far off its all-time high, and the mid-cap FTSE 250 is on a price/earnings ratio of almost 20! It’s hard to find anything I really want to buy.

But that doesn’t mean I’m going to sell all my shares in a mad rush this week. I’m in this game for the long term.

Why I’m not selling

The main reason I’m not selling is that I’m a long-term investor. I’m investing to fund my retirement in 20 years’ time, so what happens to my portfolio over the next couple of years doesn’t matter hugely. All the matters is what my portfolio is worth in the 2030s and later.

Sure, I could try and be clever and sell out now to buy back in later at what I hope will be a lower price. But you see, I’ve learned from experience that timing the market is really hard, if not impossible. One occasion I tried it was in 2011 when I decided that Apple (Nasdaq: AAPL) had become overvalued. I sold, and then saw the share price continue to rise. Eventually I bought back in at a much higher price.

Another reason not to sell is that my fund manager friend and I may be wrong. Perhaps markets aren’t as overvalued as we think.  And heck, even if markets are overvalued, that doesn’t mean that share prices can’t continue to rise from here. Markets have a well-documented tendency to ‘overshoot’ in the good times, as well as ‘undershoot’ in the bad times.

What’s more, selling at the right time is only half the battle, you’ve also got to be brave enough to buy near the bottom when everyone is panicking.

Then there’s the danger that you could miss the market’s ‘best days’. Last year,Terry Smith, the manager of the highly successful Fundsmith fund, cited the performance of the US S&P 500 index between 1994 and 2004 to support this argument.

If you had stayed invested in the S&P over that ten-year period, you’d have received a return of 12.07% a year, which isn’t too shabby. You could have turned $10,000 into $31,260 by 2004. But if you missed the ten days during that decade when share prices rose the most, you’d only have received a return of 6.89% a year, leaving you with $19,476 at the end.

Markets can go sideways

It’s also worth noting that markets don’t always tumble when they’re overvalued. They can easily bob around for a while, moving up and down within a range and effectively going sideways.

Let’s say that the FTSE 100 stays within a range of 6,500 to 7,000 over the next two years – a plausible scenario. If that happens, you might think there’s no great need to be invested in the stock market over that period. But you’d be wrong, because you’d be missing out on a nice dividend income.

Even at its current high level, the FTSE 100 is paying a 3.3% dividend yield, well ahead of gilts or a savings account. And, of course, even if share prices in the FTSE don’t rise in the near future, you can be still be fairly confident that the overall dividend payout will continue to go up. Dividends comprise a large chunk of long-term stock market returns, so why not just stay invested and keep the dividends?

So what should investors do?

I hope I’ve made a good case for not selling all your shares in a hurry. (That’s unless you think you might need the money for other purposes within the next five years.)

But I also understand that you won’t want to completely miss out on any bargains if markets do fall significantly at some point in the next couple of years. So you might consider going for a ‘drip feed’ strategy where you invest a modest sum in the stock market every month for the next couple of years. If you follow that approach, you’ll at least be able to buy some shares at cheap prices if we do enter a bear market.

It might also make sense to focus on shares that pay decent dividend yields. That’s the approach my colleague, Stephen Bland, follows in his Dividend Letter newsletter. Stephen really isn’t that bothered about what happens to share prices, he just focuses on the dividends that continue to pay out year-after-year. You can find out more about his strategy here.

As for me, I’ve been drip-feeding money into the markets for some time now and I’m going to continue doing that. And I’m not going to sell down my portfolio.

Markets may look pricey but long-term investors should continue to hold.

• This article is taken from our free daily investment email, Money Morning. Sign up to Money Morning here.

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