I know the last post I wrote was also about market volatility, but due to reader demand, I wanted to elaborate on this topic.
When I wrote the last post, the S&P 500 was down 5%. At the time of this writing, it is now down nearly 10% since the start of the year, and a lot of people are freaking out. I got this question from a reader here on the site, but it’s impossible to answer without knowing his/her risk tolerance, current situation, investment horizons, etc.
First of all, investors shouldn’t react emotionally to a short-term market decline. It’s almost always best to take a strategic, consistent, and long-term approach to investing in the stock market. You shouldn’t try to time the market and you shouldn’t be at the whim of short-term market gyrations.
This is the reaction that I see from a lot of investors, but should you average down? If you are investing in a diversified mutual fund or a broad market index, go ahead and buy while the stock is “on sale”.
This strategy is often used by long-term contrarian investors. Contrarians pride themselves in investing against the prevailing market trend. Let’s say an investor has XYZ stock in his portfolio, when suddenly there’s a sharp decline. This investor may view the decline as a buying opportunity. He’ll justify his bargain-hunting by viewing it as being at a discount to its intrinsic value. He’ll say things like, “I liked the stock at $20, but I LOVE it at $15.” He’ll hold the stock forever, or until it reaches his determination of intrinsic value.
A good example of this is when Warren Buffett purchased a stake in the Washington Post Company during the 1973-74 bear market. Buffett is a value investor, and he said that he was buying the company at a deep discount. He figured that while the company only had a market cap of $80 million, it could’ve easily sold for $400 million or more.
There are still big risks to contrarian investing. When you swim against the current of common opinion, you must do some serious research to make sure that the crowd is indeed wrong. Make sure that the drop in price is justified. For example, the September 11th, 2001 terrorist attacks had a negative effect on Boeing stock. Boeing stock would hit a bottom about a year later, but quadrupled in value over the next five years. If you did your research and were convinced Boeing would survive, you would’ve been rewarded.
Should I just stay out of the market?
Just moving to cash is awfully tempting. When you move out of stocks and other investments, you expose yourself to inflation risk. As the cost of living increases each year, your money will have less purchasing power. As you get closer to retirement, you’ll gradually want to allocate some of your money to more conservative investments, because you’ll have less time to wait out a volatile market.
However, if you’re young (like me), you’ll have time to ride it out. Stock market corrections happen every few years, and if you believe you’ll only have one bear market in your lifetime, you’re fooling yourself. According to John Prestbo at MarketWatch, the average correction (for the Dow) is 13.3% and lasts 14 calendar weeks. Corrections are inevitable, and there’s nothing you can do to stop them from occurring. All you can do is just buy more.
Well, what should I buy?
Disclaimer: everything on this site is opinion, and is meant to be an education/entertainment resource. You should always seek professional advice and discuss your own financial situation with a competent professional.
Personally, I view corrections and bear markets as a great time to pick up some dividend stocks. For example, since oil stocks are getting hammered, you could pick up some Exxon ($XOM) or Chevron ($CVX) stock. Chevron is down over 35% from its June 2014 high, and pays over a 5% dividend.
I like to get paid for owning stocks, which is why I gravitate towards dividend-payers. One good example is Emerson Electric ($EMR), which has been increasing its dividend for over fifty years. Coca-Cola ($KO), Lowe’s ($LOW), and Colgate-Palmolive ($CL) have also been increasing their dividends for over half a century. If we enter a correction or bear market, and these companies aren’t in any serious trouble, it would make a lot of sense to buy.
NOTE: At the time of this writing, I own Coca-Cola stock. I do not own any of the others mentioned.
So, if you’re going to hold for the long-term, use this volatile market as an opportunity to get some good bargains. Just be careful.