Turn on the TV and the news isn’t pretty. Rioting in London and China, the European debt crisis spreading, and the Standard & Poor’s downgrade of the U.S. rating, have sent global stock markets crashing. As a result, many investors have decided to liquidate their stock holdings. It’s hard to find a silver lining in this situation but for investors sitting with cash or for young, first-time investors, this could be an ideal situation. Now is the time for young investors to start thinking about the future, and planning for their retirement.This may turn out to be a once in a lifetime opportunity. The reason for this is that while experienced investors have been through market falls, they may also have lost money during this latest market decline. On the other hand, for those looking at the possibility of investing, this is a good time to get started. But why should novice investors take the risk now, when the markets are falling, to start investing?
Buy Low/Sell High
According to an old investment adage, one should buy when prices are low and sell when they are high. Although there is no sure way to declare that the market has finished falling, it is certain that the market would be cheaper after a 20% decline than it was 20% ago. In other words, the market is somewhat “on sale.” No one likes buying retail, and with the recent market pullback it could feel as if the investor is buying wholesale. There is no question that if a local supermarket was to run a 20-30% off sale, shoppers would be lined up around the block to have a chance to make purchases at rock bottom prices.
Blue chip companies like Johnson & Johnson (NYSE:JNJ), United Technologies (NYSE:UTX), or AT&T (NYSE:T) have dropped significantly, with no actual change in their specific businesses. They continue to pay very high dividends and they can be bought at 15-25% off where they were trading a few weeks ago. Now I am not saying to run out and buy any of these. They are just examples of what I am talking about. For a young investor starting to plan for future retirement, the current market meltodown may be a bonanza.
It’s important to differentiate between the state of global corporations and the macroeconomic state of the global economy. While the economy stinks for all intents and purposes, the financial state of many top corporations is very strong. Earnings reports continue to show strong growth with equally strong future outlooks. In this recent market rout, attention has clearly been placed solely on the murky economic situation. No guarantees, of course, but when a bit of calm returns to the markets, focus may very well shift back to corporate earnings and the realization that some very good companies are trading at very cheap levels.
One classic investment strategy is ”buying the dips.” An example of this would be to wait for a pullback of at least 10 percent in prices, whereupon the investor should make his purchase. This strategy often beats chasing sudden hot streaks that can result in overpaying — or worse, buying at the top. As for those “market timers” who want to see “for sure” that the market is moving back up before they buy, they often never get to enjoy the market rebound.
One of the biggest risks of trying to “time” the market is the potential of “missing” the market. This is when an investor, thinking the market will go down, reallocates his investments and places them in more conservative investments. But while the money is on the sidelines, the market shoots up. The investor has, therefore, incorrectly timed the market and “missed” the best performing months. Studies have shown how much an investor can lose by being out of the market. According to research by DALBAR, the numbers are telling.They looked at the returns of mutual fund investors over the 20-year period from 1986-2006, and reported the average market timer return was -2%. During this same period, the S&P 500 Index returned 12%. Additionally, during the 10-year period from 1997-2006, the S&P 500 Index achieved an annualized return of 8.4%. If an investor missed just the top 20 days during this period, their return fell to -.4%. Keep in mind, historical returns are no guarantee of future success.
Oftentimes the market recovery is so swift that by the time such investors have made up their minds to invest, it’s too late. The market will have already recovered most of its losses.
As those sitting with cash have learned, cash returns virtually zero in the way of interest. Long-term holding of cash not only costs you in returns but also in the loss of purchasing power due to inflation. Now may be the time to take advantage of the recent market plunge and take a look at starting to invest in stocks, especially dividend payers. To get started, consult with a financial adviser, who will help you to determine if stock investing is right for you.