How Investors Can Win When Stocks Fall
I’m 52 years old. I’ve been investing in the stock market for 33 years. And unlike most people, I like to see stocks drop. If you’ll be adding money to the markets for the next several years, you should be tap dancing to work when stocks fall. Before judging me birdbrain crazy, hear me out.
This follows Warren Buffett’s rule of thumb: Anyone who will be adding money to the markets for at least the next five years should prefer to see stocks fall, not rise.
Humans make horrible investors. We do. For starters, we’re backward. We typically rejoice when stocks rise and recoil when stocks fall. Only retirees or near-retirees should prefer to see stocks rise.
For the rest of us, market drops are gifts. They allow us to pay a lower-than-average price for our stock market assets. And when our globally diversified portfolios recover (and they always, eventually will) we reap rewards for keeping cool and continuing to add money.
Unfortunately, most media reporters don’t know this. They also prefer to fuel primal fears. They publish headlines such as, “Investors Lose As Stocks Fall!”A McGill University research study says negative headlines grab more eyeballs than positive headlines. And of course, more eyeballs mean more advertising dollars. But investors don’t lose when stocks fall. They win.
Jason’s Zweig’s commentary on Benjamin Graham’s classic book, The Intelligent Investor, says we should flip stock market headlines and news upside down. He says we should imagine wording like this:
“Stocks became more attractive yet again today, as the Dow dropped another 2.5% on heavy volume¬…the fourth day in a row that stocks have gotten cheaper…That comes on top of the good news of the past year, in which stocks have already lost 50%, putting them at bargain levels not seen in years. And some prominent analysts are optimistic that prices may drop still further in the weeks and months to come.”
Here’s a fun test:
You’re 44 years old. You plan to retire when you’re sixty-five. You have been investing for a handful of years, and your portfolio is valued at $31,000. You’re able to invest about $1,500 a month.
You decide to go for a 10-kilometer run. You collapse, exhausted, and look up to meet the Norse god, Loki.
He’s in charge of the stock market. He offers you two 21-year scenarios from which you could choose:
The S&P 500 averages 9.3 percent over the next 21 years. The first three years it soars, gaining 37 percent, 22 percent and 33 percent respectively. This actually happened from Jan. 1, 1995 to Dec. 31, 2015. The first three big years were 1995, 1996 and 1997.
The S&P 500 averages 6.5 per cent per year over the next 21 years. The first three years stocks fall hard. They lose 9 percent, 11 percent and 23 percent respectively. This is what happened to the S&P 500 from Jan. 1, 2000 to Dec. 31, 2020.
“Human, which scenario would you prefer?” asks Loki.
You pick scenario 1. It averaged 9.3 percent for the market and rewarded you with big profits over the first three years. You figure that sounds better than Scenario 2, which averaged just 6.5 percent over 21 years and began with three huge, calendar declines.
Loki smiles. Then he rolls on the ground and laughs.
“You are a fool,” he says. (For the record, those are his words, not mine).
When using Porfoliovisualizer.com, we can see why Loki laughed.
In scenario 1, you add $1,500 a month to your portfolio. The market averages 9.3 percent. But you didn’t get any nice, early stock market discounts. After 21 years, your money grows to about $1.07 million.
In scenario 2, you add $1,500 a month. The market averages 6.5 percent. But you were lucky enough to get three massive drops early on. As a result, over 21 years, you would end up with about $1.43 million.
In scenario 2, the market averaged a lower return. But the investor’s money-weighted return matters more. And if the investor added regular sums each month, they would have paid a lower than average price for their stock market assets. That’s what eventually juiced returns.
Warren Buffett is right.
If you’ll be adding money to the markets for the next five years, stock market drops can help you make a lot of money.
After seeing this, human instinct might tempt you to stockpile cash until you see stocks drop. But that’s a mistake. It can sabotage your wealth.
That’s because nobody can time the market.
Instead, add money whenever you have it. And if you can, keep adding money.
Most importantly, don’t think like other people. Unless that “other people” is Warren Buffett.
Andrew Hallam is a Digital Nomad. He’s the bestselling author Balance: How to Invest and Spend for Happiness, Health and Wealth. He also wrote Millionaire Teacher and Millionaire Expat: How To Build Wealth Living Overseas
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Please note the value of investments can go down as well as up, and you may not get back all the money that you invest. Past performance is no guarantee of future results.