Should I Stop Investing Since the Market is Down?
Well, the market keeps going down and I keep trying to scrounge up more money to put into it. That’s pretty stupid, right? If you read CNN Money or other sites, it seems that most of the questions asked of their financial experts revolve around "should I throw in the towel and finally pull my money out of stocks and mutual funds?" or "should I stop putting new money into mutual funds until the market stabilizes?" It seems that lots of people finally get fed up in a down market and sell so they don’t lose any more and then they buy after they are comfortable the market is going up again (hopefully not when it is higher than it was when they sold).
It’s just common-sense….right?
It is just commonsense to stop buying more stocks and mutual funds while the price is falling, right? right? Well, I know it’s a bit different, but why do people get up in the middle of the night and fight the crowds to buy a big HDTV on Black Friday – because the prices are higher or because they are drastically reduced?
Of course, we buy most items when they are on sale…so why do we not want to do the same with the stock market? Have you ever heard someone say, "hey Bob, did you see that the prices of computers have been going through the roof lately, I’m gonna go buy me one!" I’m sure, however, that you’ve had someone tell you that they weren’t going to buy any more stocks until they started going up in price again (or worse yet – they buy gold when it hits a 20-year high!).
Obviously, it would be awesome if you could easily time the market and know when the peaks and valleys were so you could sell at every peak and buy back at the bottom…but let’s assume we all live in reality for the rest of this post.
Buying things for less money is good
Since the stock market has dropped A LOT in the last year or so, the prices of mutual funds are much cheaper than they were. If you do not believe this is the end-times, then you probably assume the market will recover at some point. In that case, this is actually a great time to invest more in the market. Sure, it will probably go down more, but you’re still buying shares "on-sale." So, when is the best time to invest? As soon as possible. Don’t try to time the market or wait for the perfect time, stocks prices are down so just start some regular investing.
Dollar Cost Averaging
The easiest way to invest money (assuming you can’t time the market perfectly and you probably can’t), and probably the most common, is to employ an investing technique called dollar cost averaging. Employing DCA is quite simple, you just invest a certain amount money at set intervals. If you are setup to have money automatically invested into your 401k each pay period, then you are already employing DCA. Most mutual fund companies or brokerage companies make it easy to sign-up to have money automatically taken from your banking account and invested regularly. I personally feel this is a very simple and effective way to carry out your long-term investing strategy.
The effects of Dollar Cost Averaging in various markets
I think it’s common perception that you make the most money when the market goes up. But I’d like to look at some basic scenarios to see the effect of dollar cost averaging under different circumstances. Let’s take a look at these scenarios:
1. The market is flat
2. The market goes down and back up to original level
This will be a very simple example to simply give you a feel for the numbers. I won’t be including dividends or anything like that. Let’s say that for 12 months you invest $100 each month.
Scenario #1: The market is flat with no fluctuation
This one is easy, you invest $100 each month and the mutual fund doesn’t budge. At the end of the year, you’ve invested $1200 and the total value of the shares you purchased is $1200.
Scenario #2: The market goes down and returns to its original level
Let’s say that the value of the mutual fund you are purchasing drops each month for six months and then increases and ends up at the same original cost of $50 per share at the end of the year.
| Month | Price | Shares purchased |
|---|---|---|
| 1 | $50.00 | 2.00 |
| 2 | $49.50 | 2.02 |
| 3 | $49.00 | 2.04 |
| 4 | $48.50 | 2.06 |
| 5 | $48.00 | 2.08 |
| 6 | $47.50 | 2.11 |
| 7 | $47.50 | 2.11 |
| 8 | $48.00 | 2.08 |
| 9 | $48.50 | 2.06 |
| 10 | $49.00 | 2.04 |
| 11 | $49.50 | 2.02 |
| 12 | $50.00 | 2.00 |
Totals:
$1200 invested
24.62 shares purchased
Total value: $1231.15
As a general rule, going up is good and going down is bad, right? I actually find it quite interesting to see these numbers and how it is possible to make money by dollar cost averaging through a down market that eventually rises again. Even if the market only gets back to its original level, that is certainly not the same as investing in a completely flat market. Both of these scenarios end with a mutual fund share price of $50, but we actually make an extra 2.5% because we continued to invest when the market was down. Extrapolating this, I can even devise a scenario where you can make more money in a down and back up market than than you can in a market that just goes up.
Applying this to the current market
For a person with the money to dollar cost average and a number of years before needing the money, the best thing that can happen for your long term investing success is what is happening right now: an extended and drastic drop in stock prices. As the market goes down and stays down, the same amount of money now purchases significantly more shares. The farther the market drops, the more shares you are purchasing each period (think of how many more shares you are buying with each DCA purchase compared to a year or so ago). Of course, this assumes that the market will eventually recover and start going back up…if it does, I think you will be glad that you continued to invest money when the market is down as it is now.
Help! I’m Trying to Determine My Asset Allocation
I recently transferred a Rollover IRA and some mutual funds in a taxable account to new Vanguard accounts. Unfortunately, I have not actually done anything with either account yet. The taxable account currently consists of two funds – a S&P 500 Index fund and a global equity fund – and some cash. The IRA is completely in cash.
Asset allocation is key
After some mistakes over the past few years (more on those in a future post), I have decided to go the way of ultra-low expense index funds for these two accounts (that is why I transferred them to Vanguard). The most important component of any investing plan (other than doing something) is the asset allocation plan. That is not to say that there is one magical asset allocation that works for everyone in all situations. Rather, choosing a plan for your situation and sticking to it through thick and thin usually leads to good long-term investing results. Click here to continue reading…
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