Why a Declining Market is a Reason to SmileSeptember 11, 2015
Have you taken a look at the recent stock prices? It’s been a fairly rough few months for the market, and you may have noticed if you’ve checked your 401K balance lately. Even when there aren’t major dips, the market seems to be breaking even on average.
In times like these, it’s common for the majority of investors to begin panicking — selling off their stock in the hopes of avoiding major losses. This, in turn, further lowers stock prices, causing more people to sell off their stock (and so on). In the previous market crash in 2008, the S&P 500 Index (a common metric for gauging market performance) fell by over 50%, which would cause almost anyone to panic. Seeing your hard earned retirement savings get sliced in half can be pretty alarming. Granted, this latest dip is nothing close to the 2008 crash, but there are many who are concerned that history could repeat itself.
Now that we’ve discussed the doom and gloom, let’s take a deep breath and get over this fear. There are a few reasons why we here at SMD aren’t losing any sleep over the recent poor market performance.
Declines are imperative for a healthy market
Let’s face it, there’s no such thing as unlimited growth in the market. While the S&P grew over 30% in 2013 (!), we can’t expect that sort of performance each year. Declines will happen. The market ebbs and flows similar to seasons of the year. As the market grows more and more, typical stock values eventually become overpriced, leading to market “corrections”. It just may be that we’re experiencing a correction this year, which is no cause for alarm.
If you want to see this claim backed up with data, American Funds provides a breakdown of historical market performance to help teach us about market declines.
Lower stock prices
People view declining stock prices as a bad thing, but when was the last time you complained about lower gas prices or lower priced items at the super market? While these lower prices often represent poor performance in some area of the market, it actually provides a perceived benefit to the consumer. Lower prices means more people can afford to buy, and lower stock prices could be viewed in the same way.
Let’s look at a simple example. Let’s say you and your friend have $1,000 for buying stocks. You have your eye on an index fund that’s currently priced at $10/share. You promptly buy 100 shares. The next day, the share price drops to $8/share. Your friend uses his $1,000 to buy 125 shares — more shares for the same amount of money. The following day, the share prices jumps up to $12. Since your shares were originally valued at $10 when you purchased them, you see a nice 20% increase and sell your stock at $1,200. Your friend, however, saw a 50% increase since his shares were worth $8 when he purchased them. He walks away with $1,500 after selling his shares.
This is an oversimplification of trading stocks, but hopefully it shows you the opportunity in lower stock prices. If you’re putting away money each month into a diversified mix of securities (yay index funds!), don’t lose heart. As the market begins to recover, your investments during the market’s downturn could launch you into even higher returns over the long term. But take note — in all investments, it’s very important to consider the risks involved, and past market performance does not represent what you can expect for future performance.
That being said, let’s face reality —
The market will likely make a comeback
My worries about market crashes and downturns of any nature subsided the day that I realized that the market as a whole is driven by hard-working people like you and me. Do you believe in mankind’s desire for innovation and self-improvement? Do you believe that many people pursue a higher purpose in life? If so, it’s easy to see why so many of us see the value in investing in the market. As people pursue promotions at work, start new businesses, and continue making technological advances, the market thrives. If ever a day comes that we simply stop doing those things, then it really is time to abandon the market. Take your money and run!
Let’s even take a more unsettling look at this issue — stay with me here — do you believe that mankind has a tendency to be greedy? To want more, more, more? Guess what — this greed and desire for more also drives the market. There are simply too many greedy people who don’t want to see the market continue to decline. Job losses may occur, industries may suffer, and many people could lose a lot of money. When money starts going out the window, people take drastic measures to stop the losses. Sad, but true.
If you stand firm during these time and hang on tight to those investments you made during the good times, you can bet that the market will make a comeback down the road, and when that time comes, your persistence will be rewarded with greater returns. Remember, there are no losses in the stock market until you sell. If the market truly never recovers, then trust me, stock prices and losses could be the least of our worries.