Recently the stock market has taken a couple big dives. This has made headlines for all the major news agencies and many of the financial websites and blogs are in a panic about an on-going drop in stock prices that will wipe us all out. To me, it's much ado about nothing. Other than the fact that it does present an opportunity for me: to buy more stock.
After all, if I was willing to buy into an index fund or other investment a day earlier, I should be even more willing to buy into it the next day when it's 2% cheaper, right? And that's what I did (and usually do.) When the market takes a big hit, I move some of my cash on the sidelines into index funds. To me, it's a way to buy something I believe will go up (and I have history on my side to back this up) at a cheaper price than what I'd be willing to pay. Back in Iowa where I grew up, this was known as "a good deal."
Ben Stein recently suggested the same thing in his piece titled The Long and the Short of Down-Market Investing. The thoughts I liked best include:
Sometimes, when the traders and gunslingers drive down the price, they give us a chance to buy into long-term growth on the cheap.
As I've said before, if the market sells itself down a few percent or more, why not take advantage of the sale the same way you would a sale on paper towels or a washing machine? It's the same market, and eventually the traders will decide to start their manipulations to make the market go up. And there we'll be, with our stocks.
I'm with him 100%. I think the U.S. economy will remain strong over the long term and if stock prices take a drastic dip, then that's just a "for sale" sign to me on something I want more of. That's why I buy more when the stock market goes down.
"To me, it's a way to buy something I believe will go up (and I have history on my side to back this up) at a cheaper price than what I'd be willing to pay"
That's not true. You don't know if you have history on your side. You don't know that *if the stock market hadn't dropped* we'd be at the same place today. You may think that we have ended up in the same place, but you can't tell. For instance: imagine three periods where the market starts at 10, drops to 5 and rises to 15. You buy 5 worth of stock at time two and see a triple. Now, imagine the market starts at 10, stays at 10, and then goes to thirty. Once again, you get a triple from period 2 to 3. Unfortunately, you have no idea which of those two cases actually played out. Pick up "Fooled by Randomness" and read carefully the sections on the "invisible histories."
I like your thinking (save save save) but to think that you should defer savings to buy when the market goes down is 100% against the logic of efficient markets (and 100% against the logic of the index funds you espouse continuously).
Posted by: Kurt | April 10, 2007 at 08:55 PM
When I say "defer savings" I of course mean "defer investing" (a form of saving).
Posted by: Kurt | April 10, 2007 at 08:57 PM
I also just realized in my haste I completely screwed up my example. But my statement stands: there is no reason to defer investing because you want to take advantage of a downturn in the market.
Posted by: Kurt | April 10, 2007 at 08:59 PM
Kurt, that's not entirely true.
1) The key here is that, the short term movements of the overall market should have no impact on where the stock market will be in 20 years. So if something is worth $1 million in 20 years, would you pay for it with 150k or 200k?
2) What is being suggested here is not against the efficient market hypothesis, or why we should invest in the index fund. Suppose you have a diversified portfolio of cash and stocks, as it seems to be suggested in this case. (Let's ignore other investments such as bonds here, but the same applies) If your target asset allocation is 60% stocks and 40% cash, then when the stock prices drop, stocks are represented less in your portfolio. To expose yourself to the same amount of risk, you rebalance your portfolio by transferring some of your cash to stocks.
Two things to point out with #2.
i) If cash and stocks have the 0% return but have uncorrelated ups and downs, you can still "make" money just by buying stocks when stocks are cheap and selling when they are high. (Judged by how many percentage of stocks you have in your portfolio)
2) This is part of the reason why diversification is good. Rebalancing your portfolio to meet your target allocation is a way to give you a higher Sharpe ratio than putting all your money in one asset.
Of course, how you determine your target allocation is a completely different topic.
Posted by: Edmund | April 10, 2007 at 10:03 PM
What? Giving in to market timing now? What was that cash doing on the sidelines anyway? I agree, but I would wait for evidence it will rise or at least has bottomed. Bad days tend to be followed by bad months.
Posted by: Lord | April 10, 2007 at 10:38 PM
It's not really true that bad days are followed by bad month. That sounds more like market timing to me.
Bad days usually result in higher volatility.
There are a lot of reasons for holding cash instead of investing it in the stock market. If you need to buy a house within a year, why would you still have your down payment in the stock market?
Again, it's down to asset allocation. That depends a lot on your time horizon.
Posted by: Edmund | April 10, 2007 at 10:44 PM
"Kurt, that's not entirely true.
1) The key here is that, the short term movements of the overall market should have no impact on where the stock market will be in 20 years. So if something is worth $1 million in 20 years, would you pay for it with 150k or 200k?"
My point is that you DON'T KNOW. You can say that it will be at the same point in 20 years, but how do you know that? You only witness one history (the one that happened). Besides, if what you say is true (and enough people believe it) the situation won't arise in the first place. You can say that short term movements do not affect long-term performance until you are blue in the face, but the fact remains you have no way of discerning that. I could just as easily say that the future market levels are going to be 1% lower in 2050 after the 1% drop in the market today. You just can't tell, and to say that we should keep money on the sidelines in the hope of buying on dips is really misguided.
Posted by: Kurt | April 11, 2007 at 10:19 AM
I think people are taking this too literal - you don't just buy up stock that dropped in price, you buy stock that drops in companies that more than likely have a rebound - if there is a rumor of bankruptcy or closing the company, you aren't going to snatch it up.
However - if it's going to be bought out, that'd be something worth grabbing (TMU).
Posted by: zen | April 11, 2007 at 10:21 AM
Kurt,
You're right that nobody can know for sure. The way you say nobody knows for sure it's close to saying nobody knows anything for sure.
Anyway, the original analogy still stands. If you are willing to buy the toilet paper when it's on sale, you should buy into index funds when they get cheaper.
You can say that the 15% off on toilet paper will reduce the price of toilet paper in 20 years from now. Nobody knows "for sure" (as in 100% confidence). To me the argument just seems silly.
Posted by: Edmund | April 11, 2007 at 11:53 AM
"Anyway, the original analogy still stands. If you are willing to buy the toilet paper when it's on sale, you should buy into index funds when they get cheaper." My point is that if you like it before it "goes on sale" you should have already purchased it and therefore had no (additional) money to spend on the "sale." There is abundant evidence that market timing doesn't work, and that's all this is.
Posted by: Kurt | April 11, 2007 at 12:22 PM
If you read the comment that I posted above, I mentioned how this can fit into the framework of asset allocation.
Rebalancing your portfolio is not market timing. You are allowed to have money elsewhere, instead of putting all your money in stocks.
You can work out the math to see that setting a target allocation helps you buy stocks "on the cheap", even if the movements of the stock market is random.
Posted by: Edmund | April 11, 2007 at 12:38 PM
It's not really true that bad days are followed by bad month.
Statistically, there is an increased likelihood. The reason is correlation to underlying economics. Good days are more frequently followed by neutral months. You may not wish to act on the probability, but it exists.
Posted by: Lord | April 11, 2007 at 03:26 PM
Really, where does that statistics come from?
I would seem like it's something that can be exploited by hedge funds if that is true.
I only know that volatility goes up after the market goes down. (A negative correlation between stock prices and its volatility)
Posted by: Edmund | April 11, 2007 at 04:33 PM
I looked at Bayesian statistics of the historical Dow from Yahoo Finance in Excel. Uncertainty and trading costs make it uneconomic. After all the stock market has predicted 9 out of the last 5 recessions. Actually I believe it has been exploited by hedge funds which is why we see lower volatility than in the past. Still trading on the 200 day moving average is almost breakeven which does spell a better risk adjusted return, though not a better absolute return. This was from some Penn. professors work on technical trading. Selling after a drop is a little late, but delaying a purchase can be warranted.
Posted by: Lord | April 11, 2007 at 06:10 PM
I'd just like to say that this article is perfect timing since it day one day BEFORE today's downturn. I think there might be another few trading sessions before things will try to bounce back so people should buy more if they believe in the long term prospects of the global equity market.
Posted by: MyOwnMillions | April 11, 2007 at 08:04 PM
I do the same thing and I've been advocating the same strategy in my own blogs recently. When stocks go on sale I always buy. Good tip and many would do well to heed it.
http://www.adambourque.com (that's me)
Posted by: Adam Bourque | April 11, 2007 at 09:30 PM
I find myself on the same page as FMF. This must not be about SS. :)
Advisors, including Bernstein, recommend buying stocks "on sale". Or reallocating some bond money to stocks when the risk factor for stock drops (because the price has dropped). This is sometimes referred to as Value Investing.
On the other hand, I'd not quite call the current market prices "on sale". Compare the PE, PB, and dividend rates to the valuations that Bernstein and Bogle use. The market is still highly valued. It's impossible to say for sure, but ten year returns are likely to be lower than normal until the market drops more.
Posted by: | April 11, 2007 at 10:49 PM