WHAT HAVE YOU LEARNED FROM THIS STOCK MARKET CORRECTION?
By MARY LYNNE DAHL, CFP®
February 04, 2019
While some people have gotten out of the stock market lately, many others have stayed the course and have either done little or nothing to their portfolios or they have added cash to their portfolios. These are the smart investors. They will accumulate more wealth than those people who have gotten out. And although accumulating more wealth does not mean to “get rich”, it does mean to become more secure financially. This security is generally the goal of typical investors, so working to achieve it is important. The word “wealth” is not a measure of great riches; it is, rather, a measure of achieving the important goal of being as secure as reasonably possible.
With that in mind, why is getting out the wrong move to make when the market falls, as it has done recently (more than once). And why is it smart that some investors have added cash and invested even more money during all of this chaos?
It is smart because by adding cash, they can buy additional shares at reduced prices. It is like buying a good winter suit at Nordstrom during the yearly half-price sale. You are bargain shopping. This strategy is called “dollar cost averaging” and is a time-tested, proven way to get better returns.
Let’s say that you are invested in several mutual funds that hold stocks in the broad market and in the S&P 500, so you split the cash invested between these 2 funds. And let’s also say that at the time that you invest this cash money, both funds are down 15% from previous high share prices. You buy the shares in the funds at a price that is 15% less than the prior high price. As a result, you get more shares than if you had paid the previously higher price. Eventually, when the market rises, those share prices go back up, maybe gradually, maybe quickly. There is no guarantee of this happening, but if it does, you will not only have additional shares, but those shares will have grown in value. Voila! Your patience has been rewarded.
Example: Mr. Investor has an account valued at $32,500 that holds 500 shares of ABC fund, for which he paid $65.00 per share. Now the market has fallen and those shares also fell in price by 15% to $55,25 per share, dropping his account value to $27,625.
So in response to the market falling, Mr. Investor adds $10,000 to his account and buys the new shares at $55.25 per share instead of $65. He now has 180.996 additional shares and a total of 680.996 shares. His average price per share is now $62.41 ($42,500 invested divided by 690.995 shares).
Then let’s say that the market correction ends at some point in the future and those shares rise in price to $66.00 each. His account rises in value to $44,946 (rounded up), a gain in value of 40% (from $32,500).Even if it takes several years, his investment paid off and was a wise strategy for him to use. If he had not added $10,000 to his account and bought additional shares at the 15% bargain price, his account would only have risen by $500 ($66 - $65 =$1 X 500 shares = $500) and that is a gain in value of only 1.56%. That is how dollar-cost-averaging works and why it is smart to use in market downturns.
So, if you do not have cash to add to a portfolio, and are fed up with the ups and downs, should you just get out when it all goes bad on you? I said earlier that this is the wrong thing to do, and promised to explain why.
First, if you get out during a bad market, a correction or crash, you generally lose money. That was never the goal, I am sure. But once you sell those shares for a loss, you cannot go back and recoup later. If the only reason you do this is because the entire market is in free fall, you have suffered a loss unnecessarily in most cases, because the entire market will most likely go back up sooner or later, including your invested funds. That is assuming you invested in a reasonably good fund to begin with, not a worthless junk fund, of course. That is another article and worth reading if you are interested in how to find good fund vs a bad fund. (See my archived columns in Sitnews.)
So what evidence is there to assure you that the market will improve and reward you for being patient like Mr. Investor in the example above? Plenty. It is not guaranteed proof, of course, but it is very convincing and factual.
Example: you invested in 3 index funds exactly one year ago, on 2/1/2018. Those funds were in the Dow Jones Industrial Average index (DJIA), the S&P 500 index (SP500) and the NASDAQ index (NASDAQ). Since then, 1 year later, your portfolio has fallen in value due to a drop in share prices during that period. The DJIA index fell by 4.6% from 2/1/18 to 2/1/19, the SP500 index fell by 4.2% during that time and the NASDAQ index fell by 1.3%. The average of these 3 index declines in price is 3.37%. At one point during the last 12 months the decline in prices was even greater.
So, have you lost money? No, not if you do not sell. Instead, wait it out. Why? Because you should give it more time, like 5 or 10 years.
If you were patience, like an investor who invested in the same index funds 10 years ago, on 2/1/09, you would have been rewarded handsomely. For that period of time, each index grew in value by 312.4% (DJIA), 327.4% (SP500) and 493.8% (NASDAQ), for an average of 379.5% for the 3 index funds during that 10 year period.
The numbers are factual. Each index category of investment is commonly used by many investors. None of them are unusual or exotic. None require anything more than thrift, discipline and patience on the part of an investor looking to accumulate enough value to have a secure future, probably for retirement. Even though none of these index funds were or ever will be guaranteed, they have a very high chance of providing good returns to an investor over time. The numbers prove that they have done so in the past, and it is likely that they will, sooner or later, do so again in the future. It just requires patience and continued investment during all of the ups and downs of the stock market. Getting out during a low point is the wrong tactic to take to secure your financial future.
Unfortunately, investors sometimes give in to their emotions. Emotions are why some invesors make the mistake of jumping out, or in and out, which is even worse as a strategy. Emotions just do not have a place in the world of investments. Making a decision based on fear, panic, greed. bad advice, media hype or gossip will just cause heartache and real losses. Investing in stocks for the long term has a pretty good track record and is a reliable way to get better returns than bank interest will produce. It also has a better track record of returns when compared to bonds. Careful investors will own a diversified mix of all of these kinds of investments at various times during the long years of accumulation, and will not generally put all of their money in stock funds or any other single category of investment. However, for that portion of their investments that are in stocks funds, the historical numbers show that patience is rewarded and the returns are often better than other categories of investment. Keep this in mind when you consider what investments are right for you.
I recall many years ago hearing a person say “investing is different today. There has been a paradigm shift”, implying that new strategies and rules applied to the business of investing. This was not true then and is still not true today. While there have been a lot of changes in the investment world, the basic principles of long term planning, choosing good quality stock funds, reinvesting the earnings continuously, dollar-cost-averaging in market declines and cultivating a disciplined mind about money are still the core characteristics that insure the best returns possible for your future security.
So, what did you/we learn during this most recent stock market correction? Add money if you can and invest it in more shares. Don’t panic; it will very likely get better. Don’t sell and get out; that’s just a sure fire way to lose money. Be patient; the chances are very good that you will be rewarded sooner or later. Keep investing, through thick and thin, ups and downs; the market is a cycle and you cannot predict the direction it will go. Invest in quality, not glitzy promises. Be disciplined; become a saver and investor as a life style and make it a habit; you will increase the likelihood of being secure in retirement (and maybe sooner).
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