Stocks "On Sale"

A reader asked USA Today what it means when people say stocks are "on sale". The answer:

It's really just a general comment meaning a stock is less expensive than it used to be. It is a play on words of sorts, equating a stock price decline with a markdown on a sweater in the department store. Since the prices have been cut on both things, they're technically on sale.

As an example, let's say stock ABC is a "good" value at $50 a share. But then the market turns down, the economy stalls, investors panic -- any one of a ga-zillion bad things that can drive the market down happens -- and ABC goes down with everything else. Now let's say it's priced at $45 a share. If it was good at $50 a share, it's now even better at $45 a share (assuming nothing changed that significantly impacts the company's performance) -- a $5 "sale" that many investors will jump on.

I am a sale shopper myself when the market takes a dive. Between my emergency fund, savings for big ticket purchases (new cars, etc.), and the fact that I'm accumulating cash for a potential downpayment on a new house, I have cash on the sidelines now that I can tap into to "buy low" if (or maybe I should say "when") the market declines.

Of course, I'm buying into index funds every month already, but when there's a big sale, I like to jump in and get a bit extra. I'm a sucker for a good sale. ;-)

Comments

[Brian]

You have to love a good deal!

The only thing to watch out for is that all market declines are not the same. In some cases, there are very good reasons for the market to be down besides investor hysteria. For instance, if the Fed were to raise their rate to 10%, then there would be an absolute reason for a selloff. If the outlook for the next few years is bad, investors will certainly price that in there as well.

Buyer beware!

[Kurt]

It's only a sale if it's the same product and it's now cheaper. If I spit on your latte and charge you a quarter for it, I doubt you'd call it a sale. Unless you think you're smarter than the rest of the world, you have no reason to think that a share of GE is the same today as it was in June.

[Zot]

I think you are probably wrong on this. Admittedly you are going against the grain here, and that can be good, but in this case it's not just mortgage companies and CDO's, but it's the loss of perceived (and available through home equity loans) wealth by the consumer. As foreclosure, dropping housing prices, and a devalued dollar combine, I think we are going to see big drops in consumer spending, and that includes investment in stocks.

In my opinion it's a ballsy position to suggest buying now, unless you are prepared to hold for 3-5 years.

[FMF]

Kurt --

I buy index funds, not individual stocks, so I'm betting on the market overall to do well. And if it's on sale, I'm buying.

Zot --

1. Heaven knows I've been wrong before! :-)

2. I'm bullish on the American economy. Maybe not in the next few years, but in the long run I am.

3. My time horizon is 15-20 years, so I have plenty of time for investments made today to grow.

[FMF]

FYI -- I took some cash off the table both yesterday and today and put it into a broad market index fund.

Buying all the way down...

[Bronco]

FMF, if you are not bullish on the economy in the next few years, why buy in now? Why not wait for an even greater sale? I especially hope you don't try to purchase a new house in the next few years-- don't want to see you get burned.

[Victor]

This reminds me of those 70% off sales you can find in the Sunday paper fliers and adverts every week. Every week everything is 70% off...what a sale! The Dow was a good buy at 14,000, it's a great buy at 13,000 and it must be a best buy when it hits 9800. It's always a great time to buy, never a good time to sell.

[Market Flavor]

Stocks look cheap right now. I think we might get one more sale before the market heads back up but it's good to start buying some now.

[FMF]

Bronco --

I don't know what's going to happen to the economy -- no one does. In the next couple years, the market could go up or it could go down. All I know is that I believe in the US economy in the long-term and what I had to pay X for a few days ago I can now get for X - a bit. Seems like a good deal to me.

[Bronco]

ok, now it is even cheaper

[FMF]

Yep. Missed buying yesterday -- got into a meeting and the market closed. Doh!

[Kurt]

The problem with all this analysis is that you assume that stock prices will be the same at some point in the future whether or not they fell yesterday. Unfortunately, there is no evidence to support this (running alternate realities is always difficult). Interestingly, the theoretical basis for my statement is the same basis that people use when saying how great index funds are. So in one breath you're saying the market is inefficient, but the best way to take advantage of it is by using tools that assume the market is efficient.

Brilliant.

[FMF]

Kurt --

What I'm assuming is that the market as a whole will go up over time and, on average, at the rate of 10% per year. There's a ton of evidence that suggests this is a quite reasonable assumption.

As far as index funds go, I invest in them because they outperform most other investment options when costs are factored in. There is also substantial evidence for this line of thinking.

And as far as buying stocks when they dip, we all know that within that average 10% growth per year that there are wild swings both up and down. If you're a long-term investor and stocks drop a bit on one day (or a few) because of something you see as not impacting the long-term trend of the stock market, why isn't it a good time to buy a few more shares in an index fund?

And, by the way, what's your alternative?

[Kurt]

The alternative is being fully invested. The numbers actually work out that holding back money to "buy on the dips" is a sure-fire way to underperform the market. The idea is that for every time you pick up a percentage point, you lose two percentage points watching the market go up while you "wait for your entrance."

Listen, feel free to time the market, but don't think that it's better than investing funds as soon as they're available.

By the way, I'm all with you on the index fund idea. The reason they work so well is that they are fully invested and don't try to time the market. Seems to defeat the purpose when you do it yourself.

[FMF]

Kurt --

I am fully invested. I have all the funds I want in the market at all times. These go in regularly through automatic investments like my 401k and personal accounts through Vanguard.

But when the market drops big, it's a time to see if there's any other money I could do without for a bit to buy "on sale." That's when I tap the funds described above for an extra investment (note that these funds weren't originally meant for the market -- I wasn't sitting on the sidelines waiting to invest them.) I know I can replace them in the next few months, so why not take advantage of some low market prices?

[Kurt]

Why did you have the funds "on the sideline" in the first place? If they truly are emergency funds, seems silly to go spending them as the market drops.

[FMF]

Kurt -- Did you read what I said in the post?

[Bronco]

Kurt (and to a lesser extent FMF),

You need to learn a little about asset allocation.

[Bronco]

To avoid appearing curt, I will elaborate: a portfolio should consist of multiple asset classes (not just stocks). This is diversification not only within stocks, but ALL classes. They would include, but not limited to, stocks, bonds, real estate, precious metals and cash. Notice that cash is one of the asset classes. In a given environment, one needs to decide how to allocate across each class. For some it may be a static mix. For others it would include a dynamic rebalancing. But even in a static model, it should not be 100% stocks (although in a dynamic model there may well be an environment that one would be 100% stocks). This is not market timing but rather "not mis-timing." For example (my belief) real estate investments should now be zero given the recent dramatic run up to "unaffordable" levels. It is a matter of prudence in avoiding classes that are currently relatively expensive.

[Kurt]

Bronco, that is at least a consistent view to take (the markets are inefficient). However, you cannot couple that with a belief that index funds will outperform what you could accomplish on your own.

My points do not address asset allocation because it was not addressed in the point.

FMF, What I object to is any notion that stocks are "on sale." A sale is a discount on an item, not a change in the item itself. When markets get choppy and the outlook for the future changes, the very nature of the security you are buying has changed and therefore it is naive to call it a sale. If I spit in your latte and offer it to you for half price, that is not a sale.

[FMF]

"When markets get choppy and the outlook for the future changes, the very nature of the security you are buying has changed and therefore it is naive to call it a sale."

That's the key point. The herd thinks the future outlook has changed, but I don't. For details see http://www.freemoneyfinance.com/2007/08/going-against-t.html

[Kurt]

"The herd thinks the future outlook has changed, but I don't."
So you don't believe in efficient markets. There we go. That's all you had to say.

However, if you think you are smarter than the market, what on earth are you doing in index funds? Shouldn't you benefit from your ability to think better than the market?

[FMF]

Kurt --

I have never said that I think the market is completely efficient, have I? Can you find one reference to me saying that? Maybe that's YOUR opinion of what every index fund investor thinks, but I don't recall ever saying that. But maybe you can find something on this blog -- I'd be interested to see it if I did.

I believe that the market ebbs and flows without reason in many cases and that neither I nor anyone else can predict or impact it. Betting on a single stock or stocks is difficult in this environment because there are risks associated with the particular companies that I neither have the time, expertise, or willingness to track (and most others don't either -- including most mutual fund managers.) But at least I can understand and believe in the market as a whole. In the long run, I think it will march upward.

We'll see how my strategy plays out in years to come, but from how it's performed in the past, I'm sticking to it. It's done well for me.

And as for you, what's your great investing advice? You're certainly quick to criticize, but I don't see you offering any different solution/ideas.

[Kurt]

"And as for you, what's your great investing advice? You're certainly quick to criticize, but I don't see you offering any different solution/ideas."
As you save money. Invest it in low-cost index funds. Don't worry about short term movements (and don't try to take advantage of them). Sleep well. :-)

One wrinkle I might add is to keep more invested overseas than is a standard market-weighted basket. Invest in a basket closer to the economic distribution expected during your retirement. This will match your assets with the lay of the land (and exchange rates) when you retire. But DON'T, I repeat DON'T, keep cash laying around waiting for a buying opportunity. You can't "backdate" your trades, and the best opportunities only appear in the rear view mirror.

Data back up the notion that being fully invested beats out dollar-cost averaging (when you hold back investments to buy in later).

To tell you the truth, I don't have the time to go through all your posts, but I'll take your word for it: you don't believe in efficient markets. Index funds work because of efficient markets (you make everyone else do the legwork for you and pay the fees), and therefore it appears to me the best reason to use them would be because of a belief in efficient markets. Doesn't mean other people don't have other reasons, I suppose (tax efficiency, for instance).

And of course I'm quick to criticize: there is little value added by screaming "Ditto" when someone says something intelligent. You already have a blog; I don't need to spread your message for you. But I do need to let you know when your message could be improved.

Keep it up.

[FMF]

Kurt --

FYI, here are the details on why I invest in index funds:

http://www.freemoneyfinance.com/2007/03/why_i_like_inde.html

The part that frustrates me about this conversation is quotes like this:

"But DON'T, I repeat DON'T, keep cash laying around waiting for a buying opportunity."

I didn't say that I did this. I didn't say that I recommend doing it. And yet you still chastize me for it. That is what bothers me about this discussion -- not the fact that you disagree. It's the fact that you disagree with something I didn't do and are yet holding me responsible for it.

If you read the original post, you'll see that I had cash on the sidelines for other, designated purposes. The biggest chunks of cash were in savings for a new car (in the next year or two) and for a downpayment on a house (if we find a new one.) I took SOME of this money and put it into index funds during the decline since I saw an opportunity. It will take me a few extra months of saving to replace it, but that's ok.

So, just to be clear, I don't have cash with no useful purpose or designation sitting on the sidelines. Any cash I have is set aside for a purpose. But if an opportunity comes along, I can re-designate that cash to address the opportunity and replace the cash later.

Make sense?

[Kurt]

A few clicks brought me to this quote "that mutual funds with higher expenses ratios perform better. This isn't always (or even usually) true" (http://www.freemoneyfinance.com/2006/10/costs_matter_if.html).
The reason that statement is true is *because* the market is at least weakly efficient (that or all mutual fund managers are idiots -- which I highly doubt). So while I don't think you are a guns-blazing market efficiency enthusiast, you likely do agree with it, mostly. Afterall, as a self-admitted Boglehead, you'd be hard-pressed to call the market inefficient as John Bogle himself is one of the foremost proponents (and beneficiaries) of it:
"I know of no serious academic, professional money manager, trained security analyst, or intelligent individual investor who would disagree with the thrust of EMH" http://www.vanguard.com/bogle_site/sp20040413.html (The reason low costs give higher returns -- the main message of the link -- is that the markets are efficient enough to make it impossible to consistently beat a risk-adjusted index of the market)

[FMF]

Ok, so...

[Bronco]

Chastise me. I am the one who says it may be prudent to have some cash on the sidelines.

[Kurt]

"I am the one who says it may be prudent to have some cash on the sidelines."
If your goal is to increase returns, you are mistaken. Is that enough chastising?

[FMF]

Kurt --

You're a trip, man. You remind me of me. ;-)