One of the common refrains that usually emerges during times of market panic, when stocks are slipping, is that “the market is becoming risky.” After all, the prevailing sound-bite wisdom would suggest that if stocks fall 20% and you see your $100,000 turn into $80,000, surely you should consider selling your stocks and opt for calmer pastures such as bonds or cash equivalents.
Although jittery investors may feel the need to do something in response to their shrinking net worth, this is not a wise course of action. Here are a couple things to consider:
- First off, it’s incredibly dumb to put money into the stock market that you will need in the short-term. Benjamin Graham, the financial professor who personally taught Warren Buffett and authored The Intelligent Investor, warned us that “in the short run, the stock market is a voting machine. In the long run, it is a weighing machine.” The nature of the game is such that there is no guarantee that stock prices will recognize true intrinsic values over the course of 3-5 years. But over the course of decades, the stock market has been incredibly accurate in recognizing a correspondence between stock price and the growth of the business. From 1980 to 2001, a $25,000 investment in Johnson & Johnson (NYSE:JNJ) stock would have turned into $1 million. But the price you had to pay for the spectacular growth was immense yearly volatility—sometimes in the vicinity of 50% drops—on the way there. If you have enough money to take care of your short-term needs, your additional funds that get put into the stock market need to stay there—you’re messing with the magic of compounding if you don’t remain fully invested.
- One of the most oft-repeated maxims of investing is to “buy low and sell high.” But, as many investors know all too well, it’s hard to maintain that resolve in the face of plunging prices and dire economic forecasts. If you do your due diligence and buy sound companies that churn out profits, you should not have the slightest temptation to sell your stocks. If the news of the day is that Greece is about to explode and your shares of PepsiCo (NYSE:PEP) drop 4% that day—do you really think Pepsi is worth 4% less than the day before? It would be foolish to think so. I’d be willing to bet that Pepsi is going to continue to profit off their millions of servings each month, and I’m going to enjoy my $0.515 per share dividend each quarter that would allow me to gobble up more shares at lower prices.
- The most sane approach to investing in stocks is to never forget what those shares you buy represent—a proportional ownership in the underlying businesses of the stock. It’s easy to think of stocks as just blips on a screen that go up or down on a given day, but if you can get in the habit of thinking of stocks in terms of the claim on profits that they represent, you’ll learn to love market drops as long as you’re a net purchaser of stocks. Right now, each share of Apple (NASDAQ:AAPL) stock that you buy at around $375 represents $25.26 in earnings. As an investor, your job is to buy the greatest amount of future profits at the lowest price possible, risk-adjusted. As long as the earnings potential of the company remains intact, you should be excited if Apple falls to $300, because that means you could buy a claim to that $25.26 at a much lower price, drastically increasing your earnings yield. If you think of yourself as a business owner when you buy stock, you should enjoy market drops, because that means you can gain greater ownership of a company’s earnings at a lower price.
Don’t let market irrationality scare you into selling. If you can adopt a business owner mindset with all of your stock holdings (as long as you’re sure that the earnings potential of your holdings isn’t impaired), then there’s no reason to not sit back and watch the dividend checks roll in while the irrational investors get caught up in the hysteria of the headline news.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.