Market volatility is higher than it has been in a while. The major indices are in correction mode. Investors are wondering what’s next.

There is an old saying that the time to buy is when there is blood in the streets. That simply means to buy when the market is tanking, even if you are also taking big losses. It’s mentally hard to do, because the tendency when you are taking huge losses is to preserve what you have, not to buy more.

Looking back, fortunes have been made by following this advice. Market declines are always followed by market advances. But hindsight is perfect. We can see what happened if we bought at the bottom. However, in real time, we don’t know where the bottom is. The problem with the pithy saying is that just because there’s blood in the streets doesn’t mean more isn’t on the way.

The S&P 500 was recently down about 10%. But, it has declined previously by 40% in a short period of time. And some experts are warning of such a decline this time around. What are investors to make of this?

Is the Market Overvalued?

Knowing a bit about market forecasts can help, but they are far from perfect.

The S&P 500’s 12-month forward price-to-earnings (P/E) ratio looks at earnings estimates for the next 12 months versus the current share price. That number has fallen from 22 to 20 since this correction started, but it fell to 14 in 2018 and as low as 13 during the 2020 pandemic sell-off. The level over the past decade has mostly hovered between 16 and 19. From a historical perspective, the market could still be somewhat overvalued.

Most experts assert that a repeat of 2021, in which the S&P 500 gained 27%, is highly unlikely this year. Gains this year are more likely to be driven by earnings, which are expected to be modestly higher. Therefore, the upside potential at present appears to be limited.

Again, no guarantees. There is some reason to believe the downside risk is higher than the upside potential this year, so that would imply that there is an elevated risk in deploying money right now. But there is a strategy for this situation.

Dollar-Cost Averaging

You have probably heard of dollar-cost averaging. This is simply a strategy of making periodic investments into the market. If you are investing in a 401k plan through your employer, you are already employing this strategy.

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If you have money to deploy, dollar-cost averaging is a great strategy when the market is declining, and you are worried about further declines. As the market declines, each periodic purchase nets you more shares than the previous purchase, lowering your overall cost basis. It’s a way of hedging your bets in a declining market.

However, should the market defy expectations and take off this year, dollar-cost averaging is a worse strategy than putting all of your money to work immediately. But you are taking a gamble there about whether there are more declines ahead.

Nevertheless, dollar-cost averaging is a better strategy than trying to time the market. If you have your money on the sidelines, awaiting a better entry point, then you should consider dollar-cost averaging as an alternative.

PS: To guide you through these perilous times, our analysts have compiled a special report of seven shocking investment predictions for 2022, and how to profit from them. To download your free copy, click here.