The stock market has been on a roller coaster ride this month. Just over a week ago the S&P 500 fell from over 2,100 to below 1,900, a drop of more than 10%. Then it recovered to finish last week at just under 2,000. What a ride!
The financial press had a field day. Here are the front page articles from the WSJ during this time:
8/21 (Friday): Growth Fears Send Stocks Into Skid
8/22-23 (Weekend): Stock Plunge Picks Up Speed
8/24 (Monday): Market Rout Upends Winners, Losers
8/25 (Tuesday): Markets Reel in Global Selloff
8/26 (Wednesday): Late Tumble Dashes Hope for Rebound
8/27 (Thursday): U.S. Stocks Come Charging Back
8/28 (Friday): Ruling Clears Way for Unions (Note the stock market doesn’t make the front page)
8/29 (Saturday): Swings Don’t Shake Investors
The last headline is my favorite. It’s like the police officer trying to keep the foot traffic from gawking at a crime scene. “Nothing to see here, folks. Just move along.”
It’s during these times that long-term investors who also happen to write about investing give sage advice. We’re told not to look at our portfolio balance if the market is down. We should remember we are in it for the long term. This has all happened before, and the last thing you should do is sell. Yet somebody is selling. That’s why the market is in a free fall!
The above advice is solid. I’ve given it and followed it many times before. But underlying this advice is, I believe, a very dangerous and mistaken assumption. The assumption is that a falling market is bad. It’s something we should dread and not even look at. We should follow the cops advice and just move along.
Wrong! Wrong! Wrong!
Falling markets, whether stocks, bonds, real estate, or tulips, provides the single best opportunity to build wealth. It’s what we do during these times that can make all the difference in our financial lives.
So rather than fear a falling market, here are three reasons to cheer.
1. New Investments: As we make new investments our money goes further. We are able to buy more shares of a mutual fund, ETF, or stock for the same amount of money. We should get as excited about a stock market crash as we do when the price of gas drops by 10 cents. If you contribute regularly to a 401k, take a look at your statements this year. Assuming you’ve contributed the same dollar amount each paycheck, check out how many shares of each fund you’ve actually purchased. It varies based on the price at the time of the contribution. As the price goes down, the number of shares you are able to buy with your contribution goes up.
2. Reinvested Dividends: The same is true as you reinvest dividends. If the price of the mutual fund or stock has gone down, the same amount of dividend will buy more shares. As you did with your 401k, take a look at your dividend reinvestments. I’ve noticed that as dividend investments go up in value, the number of shares each dividend buys goes down. When the price of a stock goes down, however, the dividends buy more shares. I see this very thing in action as I watch my investments in Personal Capital’s free financial dashboard.
3. Share Buybacks: Some companies buyback their own shares. When management pays more for a share than it’s really worth, the transaction is bad for investors. But when smart management buys back shares for less than the company’s intrinsic value, it’s a boon for investors. As the price of a stock falls, these buybacks can purchase more shares for the same amount of money (hopefully at less than the intrinsic value of the company). The result is that each investor’s stack in the company goes up. And it goes up by more when the buybacks are cheaper.
I would much rather buy the S&P 500 at 1,000 than at just under 2,000. Of course, you may be thinking that 1,000 is an insanely low price. When was it last below 1,000? 2009.
So what about retirees? Surely they don’t want to live through a market crash. Yes they do, so long as they are invested correctly. Money in the stock market should be for long-term investments only. In my view that means 5 years or longer. Money that a retiree will need over the next five years should be in high interest savings accounts, high yield CDs, and perhaps short term bond funds. As for the longer term stock investments, they will benefit from the lower prices of a stock market crash via dividend reinvestments and share buybacks. Even if they spend their dividends the lower price of buybacks will benefit their portfolio.
Here’s hoping for another crash!