35. Upside Down

Sometimes, it's worth looking at the world upside down.

When you look at falling stock prices, you should ask yourself: Am I a buyer or a seller?

If you're an investor, like me, you're a buyer. In this case, why should you be worried about falling prices? A market crash just means that stocks are cheaper, and you'll get more shares for you hard earned money. In fact, annual rebalancing and periodic, consistent investments force you, in a way, to buy low and sell high.

To illustrate this point, look at the stock market in the last 5 years. You can see the chart here:

The DJ opened at 12,090 at the beginning of this period, and closed at 11,433, or down 5.4%. Pretty dismal, all in all: a $100 invested in Sep 12, 2006 would give you $94.60 in Sep 12, 2011.

Now, suppose that instead of investing these $100 all at once, you invested $20 every year on Sep 12th. The DJ was reading the following values (approximately) on 2007 through 2010: 13,443, 11,388, 9,820, and 10,608. Even though the DJ ended up below its value at the of the period, your total investments will be worth $100.84, or 6.6% more than the alternative of buying and forgetting. Note that the time I selected was quite random, based on today. An investor who chose March 23rd as her annual day would have fared much better. An annual rebalancing against a conservative bonds funds would have had even more dramatic results: assuming a 60/40 balance and 0% growth for the bonds funds, your $100 would have been worth $120.80 at the end of the period: a gain of more than 20% in basically a flat market. Not bad at all! (I'm neglecting the value added from the bonds funds and also the commissions - these will not influence the result greatly.)

Why did this happen? Because in some years (such as the wonderful 2009), the market crash made stocks so cheap that your $20 got you much more than in so called "good" years. Furthermore, if you followed a rebalancing plan, you had to buy a lot of stocks this year. You've made market fluctuations and instability work for you.

In a sense, an investor who's not going to spend the money in the coming 5-10 years should hope for a market crash, in the same way that a renter who's looking to buy a house should be happy with the house bubble crash. As long as you believe that the long term prospects of the US economy are goods, you're going to win.

Let the sharks of Wall Street and hedge fund managers worry about falling prices. For us simple people, as Warren Buffet famously said, there's no reason to worry if hamburgers - or stocks - get cheaper.