Why VOO Makes More Sense as a 20-Year Hold Than a 2-Year Trade, Even at Today's Valuations

A lot of fuss is being made right now about the Shiller CAPE ratio and what that means for equity market returns going forward. This ratio measures the price of the S&P 500 (SNPINDEX: ^GSPC) relative to inflation-adjusted earnings over the past 10 years -- and it is currently sitting at 42.

This ratio has only been this high one other time in history: just before the tech bubble burst in 1999. In fact, if you want to look at the only other time this number has even been above 30 (prior to this past decade), you'd have to go back to 1929, right before the Great Depression. That's not exactly good company to be in.

Studies have also shown that investing when valuations are higher tends to produce lower forward-looking returns and vice versa. Drawdowns at higher valuation starting points tend to be deeper as well.

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But should that discourage long-term investing in a fund like the Vanguard S&P 500 ETF (NYSEMKT: VOO) altogether? Over the past century, the average annual return for the S&P 500 has been around 10%. Over long time horizons, the returns on large-cap stocks far outpace every other major asset class, including gold, real estate, Treasuries, and investment-grade corporate bonds.

Even if you earn 7% to 8% per year over the next two decades because your entry point is more expensive, you're still looking at superior returns compared to fixed income, which currently has yields of around 4% to 5%.

Getting in is more important than where you get in

Over that long a time horizon, there's plenty of time to ride out short-term market volatility. You may be buying U.S. stocks at a more expensive price, but the capital growth you'll likely see thanks to 20 years of economic expansion is too costly to pass up.

That volatility is also the reason why short-term trading in longer-term securities is a bit like gambling. Sure, you may enjoy gains similar to what we've seen over the past few years. Or you may run into a situation like 2022, where stocks and bonds were both falling sharply at the same time. But there's so much uncertainty that it's difficult to say whether it'll pay off.

That's why I'll always choose investing in the Vanguard S&P 500 ETF for decades, even if the entry point is expensive versus trying to trade it in the short term. Investing in the S&P 500 should be viewed as a long-term investment to maximize the chance of success.

If you're really worried about investing in stocks at historic valuations, consider dollar-cost averaging into a position. Investing periodically will lower your overall cost basis, and if the market happens to correct in the meantime, you'll be able to pick up some shares at a discount.

Either way, the S&P 500 is one of the best long-term wealth creation machines there is. Where to get in isn't as important as getting in and staying in.

David Dierking has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Vanguard S&P 500 ETF. The Motley Fool has a disclosure policy.