Keep your head in the game even in the markets darkest moments.
By Gene Walden
Its a lesson learned many times over in recent years: buy on the dips. For the past two decades, every time the market took a significant fall, investors who bought on the dip were soon were rewarded with a profitable bounce.
But the year 2000 taught investors a new lesson: there are no sure things in the stock market. With few exceptions the Dow blue chip stocks were anemic and the NASDAQ was abysmal. Anyone who spent the past year buying tech stocks on the dips knows now whats it like to be kicked right in the assets. Instead of the dip and bounce, it was the dip, double-dip, and triple-dip.
Investors lost a whopping $5 trillion in market capital over an 12-month perioddwarfing any market collapse in the history of the U.S. stock market. At times like these, its easy to second-guess your investment strategy. And perhaps some second-guessing is in order. Once youve experienced the markets dark side, you may have a better sense of what your threshold for risk really is. You also may have a better appreciation for diversification, dollar cost average, and some of the other conservative tenants of investing.
Just dont get carried away. The one thing you dont want to do is make a radical change in your investment approach. Remember, the past year was an exception. Most years, the market goes up. In fact, the Dow Jones Industrial Average has set new highs 17 of the past 20 years. The odds still strongly favor investors who keep their money in stocks.
So what should you do in a bear market? If youre a long-term investor you do roughly the same thing in a bear market that you would in a bull market. You buy right through it. You make a continuing series of small bets. You select good quality companies and continue to build a position in those companies.
No question about it, its hard to get psyched up to invest good money in a bad market. In fact, its hard to keep from selling out of a bad market. You see your net worth continuing to fall. You see the money you invest being swallowed up into the steady slide of the market. You worry that the market may never turn around, and that all youve worked for, saved for, sacrificed for, will be lost.
Those types of emotions have caused more than a few investors to fail in the market. Fear drives many investors out of the market at the wrong timewhen the market is near the bottomjust as greed lures them into the market at the wrong timejust as the market reaches an all-time high.
Thats why its important in times like these to focus on the long-term. And from a long-term perspective, market divespainful as they may seem at the timeare the best times to add to your positions. Successful long-term investors see bear markets as "buying opportunities," when you can get stocks at bargain prices. Dont think about how much youve lost. Think about how many more shares you can buy for the same amount of money.
The worst sustained bear market of the past half century occurred from 1968 to 1981 when the Dow Jones Industrial Average essentially stood still for 14 years. Now thats a bear market! But even during that bear market, including dividends, you still would have earned an average annual return of about 4.3 percent. And thats if you didnt invest at all during that 14-year period.
But if you had continued to invest on a regular basis during that period, you would have set up your portfolio for a long and prosperous run. Once the market turned around in the early 1980s, investors who had a position in the market enjoyed exceptional returns over the following 15-year period.
An investor who added $10,000 a year each year for 14 years from 1968 through 1981the worst period of the stock market of the past half centurywould have seen his or her $140,000 investment grow to about $2 million by 1995 and $3 million by 1997. Thats an average annual return of about 15 percent. And all as a result of investing during the stock markets darkest hours.
An investor who bought into the market right after the crash of 1987 would also have fared very well over the next 24 months. From its low of 1739 in the fall of 1987, the Dow moved up to about 2700 by the end of 1989a two-year return of 56 percent. Thats why it would be a mistake to sell out of the market or cut back on your investments during slow times. Because once a market bottoms out, the returns on the bounce can be exceptional.
The hardest part is hanging in there while watching your investments plummet. Next time the market is tanking, and your commitment to stocks is wavering, here are some thoughts to consider:
Investing is a marathon, not a sprint. Wall Street experts tend to be on a different schedule than you. Theyre running a sprintlooking for the best possible short-term returnswhile youre in a marathoninvesting for the long-term. So when you listen to the Wall Street experts, you run the risk of getting caught up in their game, not yours. You dont have to be concerned about the price of stocks today, about the next Fed meeting, or about whether IBM makes its numbers. Those are all short-term distractions. All you have to do is ask yourself whether the long-term prospects of the U.S. economy are solid, and where the electronics, medical technology, telecommunications, financial, and consumer markets are headed over the next 10 to 20 years. Clearly, unless we experience an unprecedented economic meltdown, long-term prospects continue to be strong for a broad range of American industries. Thats why its important for you to focus on the long-term and invest with an eye on the future.
The market always sets new highs. There has never been a crash of the U.S. stock market so severe that the market didnt ultimately return to its former high, and move beyond it. Thats not to say it couldnt happen. In the 1970s, the NASDAQ dropped dramatically, and did not return to its former high for about three years. After the recent market collapse, it may be some time before the NASDAQ returns to its all-time high of about 5100, but if history is any guide, the NASDAQ will ultimately rebound.
The goal is to build a winning portfolio. Your job as an investor is to build a portfolio of successful companies. If you can get a break on the price of those stocks while the markets in the tank, all the better. Just keep building. Over time, that portfolio will serve you well.