A Healthy Reminder That Stocks Don’t Always Go Up

Bull markets are glorious because they make just about everyone participating feel like they’re a genius investor.

Until the markets reverse and you lose money. Sometimes a lot of money. Then you feel like crap as you watch your net worth plummet.

This month we’ve seen some long-awaited volatility return to the stock markets. After 15 straight months of steady positive gains, February arrived with a welcome correction.

A correction is Wall Street jargon for down 10%. Not to be confused with an official bear market which is when markets are down 20%.

Peak-to-trough (more jargon for you), the S&P 500 was down 11.8% from its January 26th highs to the February 6th lows.

Since I’m still relatively young and my investment horizon is decades long, I’m usually happy to see the stock market decline. Lower prices mean higher yields to help build income streams and earn better total returns over the long haul.

I’ve had some cash on hand in a retirement account because I transferred money out of my previous employer’s 401(k) plan into an IRA. This decline was a good opportunity to put some of that money to work in index funds since I didn’t invest it all immediately after the transfer.

These investments won’t impact my taxable income portfolio. Since I haven’t had a paycheck in more than four months, there’s still not much to invest. But now that I’m back to work, I hope to start investing more aggressively for dividends again soon.

Fall and Rise

The stock market tends to fall quickly and rise more slowly. As David Gardner of the Motley Fool tweeted and mentioned on his podcast recently:

“Stocks always go down faster than they go up, but they always go up more than they go down.” —Me

— David Gardner (@DavidGFool) February 5, 2018

When stocks fall quickly, the headlines are always sensational. The other day I saw multiple news sources reporting this was the largest point drop in the history of the Dow Jones Industrial Average.

Though true, that sounds scary to many ordinary investors.

As a percentage, it was only down 4.6%. Not a good day, but far from being historically significant.

This recent fall in stocks was followed by a swift rebound, so we didn’t have much time to perfectly buy the dip. Probably because everybody else was buying the dip since the fundamentals of the economy seem to be sound.

Unemployment is low. Corporations got a giant tax cut. Inflation is tame for now (though CPI is starting to make people nervous).

Now that volatility is here, there’s a good chance it will stay a while as the markets digest the economic data.

In case there’s another swift decline, it doesn’t hurt to keep some cash on hand. That doesn’t mean to sell stocks today to build up your cash reserves. It just means if you have cash in an account, or your monthly cash flow is rockin’, it’s not a bad idea to speculate that the market will decline below today’s level again and to be ready for it.

Some people might call that timing the market and scold you for it. But as long as it’s a small portion of your assets, waiting for better prices is another way to add speculation to your overall portfolio. If you can pick up shares 10% or 20% or more below the market highs, it’s easy money when the market inevitably recovers. The only downside risk to that kind of speculation is lack of gains.

Yet Another Oft-Repeated Buffett Quote to Illustrate a Point

Unless you’ve hired an adviser or subscribe to a stock newsletter, you’re on your own to make investment decisions. There’s a ton of information out there, but processing it into buy or sell orders takes time and due diligence.

For many investors, it’s not worth the effort. That’s why passively investing in index funds and ETFs has become so popular. You get market returns for doing very little work. It’s the smart money move (that could be preventing us from becoming rich).

I’ve seen a lot of new investors become vocal advocates for pure index investing. They’ve made great returns in the bull market run since the March 2009 bottom. So have stock pickers.

But bull market returns should not be mistaken for making smart individual investments. A rising tide lifts all boats. Nearly everyone investing in stocks during a bull market does well. The only ones who aren’t, are the people who don’t invest (about half the population).

Down markets, on the other hand, are where the decisions of individual investors can make a big impact on long-term gains. They can make costly errors (sell near the bottom) or turbo-charge their long-term returns (buy near the bottom).

You’ll never buy the exact bottom, and that’s OK. Within a day or two of the bottom is still good.

Since stocks always fall faster, it’s a shock to the system and to individuals. The sharp falls, combined with the media hysterics and the sudden depletion of wealth can make people do funny things.

Even though everyone knows lower stock prices means you should hold what you have and buy more, many investors do not. They sell despite the famous Warren Buffett quote: Be fearful when others are greedy and greedy when others are fearful.

But when scary market volatility arrives, few have the cash ready to buy at the lows. That’s a downside of always being fully invested.

Buffett always has the money.

People sell in down markets for lots of reasons. Fear is a big one. To preserve capital is another. Or to take a tax loss (a euphemism for buying high and selling low).

This market hasn’t been a straight shot up since 2009. It’s been difficult at times and can get a lot worse.

But over the last few years, especially the past 15 months up until late January, investing in stocks has felt like easy money. About a year ago, my young coworkers were bragging about winning trades they made on the Robin Hood app (I prefer M1 Finance, also free). Up until this month, they were still bragging.

However, this recent sell-off is a healthy reminder that investing does get more difficult.

That said, if we reach new highs again soon, and the last few days we’ve been going in that direction, investors will quickly forget about last week’s dip and investing will seem easy again. Until it gets worse.

I Will Now Look Into My Crystal Ball and Tell You Exactly When it will Get Worse

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Conclusion

The moral of this blog post is as follows:

• Corrections and bear markets are great for long-term investors. Be happy we had one.
• It’s OK to not be fully invested all the time. Have some cash on hand for the next downturn. Buffett always does.
• You’ll never buy at the exact bottom. Within a few days of the bottom is still really good.
• Investing gets harder than this. Seemingly healthy companies can go to zero. Indexes fall 30% or 40% or more.
• Don’t invest in stocks if you can’t afford to lose money. Keep the long-term in mind when the market tumbles. Smile and buy some more. Remember it can always fall further.

Did you invest in stocks or funds during the market downturn? What did you buy?

Photo credit: bluebudgie via Pixabay