Take Advantage of a Declining Market
You’ve heard it a million times, but the average investor who saves regularly by contributing to a 401(k) or IRA every paycheck can benefit from reduced volatility because of dollar cost averaging. If you plug away and invest $100 each month regardless of what the market is doing, you’ll be utilizing the same amount of money, but buying more shares when prices are low, and fewer shares when prices are high. Over time, this averages out your purchase price and eliminates some of the risk (a more correct term would be volatility) with trying to time the market.
Now, this isn’t a difficult concept to understand, but many people fail to realize how this can help them, and will do completely the opposite. They will abandon their regular investment plan and contribute more to their investments when the markets are doing good, and reduce their contributions when markets are bad. This makes your average purchase price much higher since you’re stocking up when prices are high, and buying less when prices are low! The end result is that over time, you’ll significantly hurt your total returns.
Don’t Be One of These People
Over the past week, I’ve received a lot of calls and met with a number of concerned investors. With all that is going on in the world of finance, it doesn’t really surprise me that people are a little stressed out. But what does surprise me is the completely backward way of thinking when it comes to how much they should be contributing to their retirement plan.
The most common action I’m seeing from investors is people who are reducing the amount of money they save each paycheck. That’s right, the market has taken a dive, and their investments are around 20% cheaper than they were a year ago, yet people think the best course of action is to save less. I’m not exactly sure what the rationale is for this behavior, but I guess some people think that their money could be better served not going into something that has been decreasing in value. I think that goes with the inability for some people to focus on the long-term rewards. Yes, in the past year it may have been painful to see your balance decrease, but that shouldn’t overshadow the fact that by continuing to plug away at saving, you’ll find yourself in a much better situation 25 years from now.
The other common behavior I’m seeing a lot of are those who stop their contributions completely. The market has them so scared that they feel saving nothing is better than saving something and getting a match with the possibility of losing money. I have to wonder, if someone who’s saving 10% of their paycheck suddenly stops saving completely, what are they doing with the additional $100 or so per paycheck? If it isn’t going into the bank, or straight to paying off debt, chances are it’s just getting blown into the wind on purchases that they were doing without while saving, resulting in a 100% loss. If you’re giving up free match money on top of that, you’re really losing out.
Think of Your Investments Like Groceries, Not a Bank Account
The problem is that people view their investments, or retirement accounts as a bank account because every day, every month, or every quarter, you receive a statement that attributes a dollar amount to it. Just like your bank account, you see that balance as the bottom line, and you hope it doesn’t go down. This is the wrong way to look at your investments, and unless you treat it differently, you’ll find ways to get depressed over market fluctuations.
So, if you invest every two weeks or every month, think of these payments as a grocery purchase. Now, when you go grocery shopping, you probably have a fixed budget, or spend roughly the same amount each week. Because of that, what do you do? That’s right, you find sales and maximize how much your money will buy. The same should be said for your regular investment purchases. Every paycheck or each month, you have roughly the same amount going into your investment or retirement account. So, what should you do? Exactly, take advantage of sales, or low prices.
Think of it this way. If you need to buy toilet paper this week and notice it is on sale for about a 25% savings on a 4-pack, are you going to buy two packages knowing it probably won’t be on sale the next time you need to buy it, or do you buy just a single roll because the price has dropped? The answer is obvious, but unfortunately, it’s hard to think of purchasing investments in the same light, even though the same general principle applies.
Take Advantage of Your Accumulation Years
As Generation X and Y, we’re in a prime position to take advantage of what has happened in the markets both back in 2000-2002, and what’s happening right now. We’re in the accumulation phase of life, meaning we’re trying to stash away as much as possible while still working so that we’ll have a comfortable nest egg in 20-30 or more years. Market corrections like these are the equivalent of a year-end blowout on last year’s merchandise, and if you can buy and stock up now, you will get much more for your money.
This doesn’t mean you should throw caution to the wind and carelessly invest your money in anything, because you should still create a diversified portfolio and take advantage of what works best for your risk tolerance. But the last thing you want to do is save and invest even less just because the balance on your quarterly statement may go down. Since we’re generally talking about a few decades left until needing the money, the markets will recover, whether it’s this year, next year, or even a couple years from now. And if you stocked up when things were on sale, you’ll be thankful you did.
Author: Jeremy Vohwinkle
My name is Jeremy Vohwinkle, and I’ve spent a number of years working in the finance industry providing financial advice to regular investors and those participating in employer-sponsored retirement plans.
I wonder what will happen to people who take your advice if you are wrong. They only suggestion ever given is to
"Ride it Out". I am 60 years old and I lost a very large amount of money that will never come back. To encourage
people to keep investing may totally ruin some lives.
If you are over 50 there is a very strong chance you will be dead by the time we recover.
I see little evidence of a recovery anytime soon and much more capital may be lost. There is surely a point where the loss is
so great that you will never recover. The always used line that historically the market always recovers may be not
accurate for today’s not so typical market. I personally will never invest again. I prefer to keep at least something to
retire on and not gamble it in a very uncertain market. I’m fully aware some of you will label me stupid and call me too weak to
be in the mutual funds. I hope I am wrong and those of you that stay with the “Ride it out crowd” don’t regret your choice.
I simply do not trust the market today and doubt I ever will.
This is a good article. I personally have doubled my 401(k) contribution and am buying up my company's stock through the 401(k) plan with tax free money. With the market down so much, it's like a double discount.
I wonder at times if it would be better if people couldn't see there 401k statements. Ludicrous as that sounds, think about pensions and social security. The investments behind those fluctuate every day, but you never see that.
Imagine if you got a monthly statement in regards to your social security benefits. One month your guaranteed income would be $1200/mo and then the next month it would be $500/mo. Wouldn't that be fun for a lot of people?
I would say that this material fits along the theme of having a bit more self-control in one's daily activity. It can be easy to see a small sign, and assume that it is a message to make quick change, but one has to remember that a social rise or decrease runs based on different factors than a natural rise or decrease. People tend to make decisions to buy or sell as a group, and so one might need to extricate themselves from following the group if they want to have a chance at separating themselves in an upward direction.
This is especially true if you are more than 10 years away from retirement. There is no need really to worry about your retirement savings now, instead just worry about increasing the amount of money that you put into these savings.
Your post comes at a good time. I'm sure there are a lot of people thinking they need to cut back on investing until the market is corrected. But you can buy things on sale now.
If you have a monthly plan for investing. Stick to the plan and things will be okay.
Sean, I think in some ways, the markets are efficient. But looking back to just last week, we can see that there are many times when that clearly isn't the case. Just look at how the market dropped nearly 8% early in the week, only to recover almost completely by Friday's close. All of this was based on surprise news. Aside from some of the companies directly affected, did the value of the companies in the broad market really drop 8% in two days? Did they suddenly become 8% more valuable a few days later?
So in a broad sense looking at longer periods of time, I'd argue that the markets are pretty efficient. But in times of distress or euphoria, irrational behavior can do more to drive the markets into these bubble and bust cycles that we're starting to see. This probably has a lot to do with the way the markets have evolved over the past 50+ years, who's investing, and how easily the information can be instantly spread across the world.
Great post Jeremy, a lot of investors get scarred and run off when they see falling prices. For further analogy suppose I would sell you a 2009 bmw for $1000, when you KNOW its worth at least $50k. Are you going to buy it? Or scratch your head contemplating whether or not its worth it? The same thing applies here, great companies are going on sale, giving investors the prime opportunity to load up on some quality companies looking forward to the future. I’ve got my eye on a few undervalued mining companies and I’ve been searching for places on how to properly place value on these kind of companies. I found a neat post I thought you might be interested in http://www.stockresearchportalblog.com They have a17 part SERIES on the topic, I’ve only gone through a couple but its definitely a solid read.
Fantastic post. It is an important reminder that I really needed. I have been scared of the markets for the past couple weeks, but I am just barely sticking with my investment plan of consistancy. Your thoughts are helping me out!
This is assuming that the dip is short-lived (decade or two at most). Pumping money into a declining market is not always a way to get things on the cheap. For instance, it took many many years to recover if you were dumping money into a declining market in the early 30s.
Keep contributing, but it's reasonable to send a higher percentage to MM account or something similarly stable(?) and liquid (?) for the time being.
My dad's portfolio adviser is meeting with all his clients this week and I'm guessing he's planning to reassure them and keep them from pulling out their money.
Amen brother. My wife and I maxed-out our IRAs last week and invested near the bottom. It's too bad I couldn't invest more!
One of my (many) finance professors is fond of the groceries analogy you shared. I wish more folks would think in the same way.