The Stock Market Is Way Down This Year… Here’s Another Way To Think About It

On December 31, 2007, the S&P 500 closed at 1,468.36. Just two months later, on February 29, 2008, the S&P 500 closed at 1,330.63. That’s a 9.4% drop in just two months, an incredibly painful loss for almost everyone invested in the stock market. Even people who were invested in a highly diversified index fund felt the bite from this big drop.

Think about it – if you had $10,000 in the Vanguard 500 on December 31, your investment is now worth about $9,060 (give or take a dollar or so) – a loss of $940. Poof! Gone like that.

A lot of people see this as a reason not to buy stocks or to sell them. In fact, a lot of people do just that. They look at these losses and see danger – and they don’t want danger, so they stay out or they sell.

Let’s look at it another way.

On December 31, 2007, you could have spent $10,000 to buy shares in the Vanguard 500. On February 29, 2008, those shares are now on sale for $9,060. You’re buying the exact same thing, except now you’re saving $940.

Nothing fundamentally has changed about the investment itself. You’re still buying the same pieces of a wide array of large American companies. The only difference is that right now, these stocks are on sale.

Let’s keep this logic going. Let’s say over the next two months, the stock market rebounds and it goes back up to 10,000. You’ll score a very quick 10.3% return on your investment.

On the other hand, if it goes down yet again, your losses now are much smaller than if you had bought in on December 31.

What’s the idea? A down market isn’t a time to sell. It’s a time to buy. You don’t go to the supermarket and stock up on produce when the prices are expensive – you wait until things are in season and the prices are low.

What if I already own that index fund and I just took that loss on the chin? What if you came into this downturn already owning a fund, and you’re sitting there swallowing losses? This is the scenario where it’s tempting to sell and stop the bleeding.

Look at it this way, though. You’re already stuck with this loss – there’s no way of getting out of it. On the other hand, you’re currently holding an investment that’s at a discounted value. If you’re investing for the long term – and if you’re in stocks, this really should be a long term investment – then you need to hold onto that stock, not sell. By selling it now, you’re basically asking someone else to come in and take that discounted investment from you at a nice bargain price.

What if I own individual stocks? Individual stocks are potentially different. First of all, if you own the stock of a specific company, you should have specific reasons for owning it. Perhaps you have high confidence in the current management, or you believe in a specific product of the company. The reasons can vary, but if you don’t have a clear reason – and also a clear definition of what needs to happen for that reason to go away, you shouldn’t own the stock.

Let’s say, for example, that you own Apple stock and you do so because you believe in Steve Jobs. As long as he’s firmly in as CEO, you’ll keep holding Apple stock. When word starts being whispered that perhaps Jobs is about to retire, it may cause some serious tremors in Apple’s stock, and it might have gone down a bit when you hear the news. Of course, your reason for owning Apple is now gone, so you should sell – but that reason to sell has nothing to do with the stock price at the moment.

In the end, keep one thing in mind: stocks are a long term investment and if you sell based on what the price is doing today, this week, this month, or even this year, you’re asking for a smarter and more patient investor to take your money. Don’t sell any investment unless you have a reason for selling it, a reason not based on that day’s price.

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  1. My stocks are all way down, but I try to look at it from a long term perspective. Even though I’ve taken a big hit, they’re likely to start inching their way up within the next 2 years. If I hold onto them until I retire, I should have a pretty sizable return. I think it’s similar to when people hold onto property for a 30 year period, there’s highs and lows in real estate, but it’s the long term investment that usually makes the difference.

  2. squawkfox says:

    My approach is to avoid listening to the media’s doom and gloom market stories. If it’s news it’s noise.

  3. Johanna says:

    That’s all very well, but as a (fairly) young person who’s already following a plan, I don’t have any spare money to buy stocks WITH. Sure, I am shoveling money into stock funds in my 403(b) and Roth IRA, but I’d be doing that anyway, whether the market was up or down. I have a good chunk of change in bonds and in cash, but that’s in bonds and cash for a reason – the bonds for diversification, and the cash for a down payment on a condo someday.

    Saying “the market’s down, so now is the time to buy” implies either that we should take money that we’d allocated to bonds and cash and put it into stocks, or that we should have been sitting on a pile of cash for the very purpose of buying when the market is down. And neither of those is a terribly great idea.

    Put another way (maybe I should ask this in the “Ask Trent anything” thread): Have you, Trent, moved money to stocks in response to the down market? If so, what were you doing with that money before?

  4. Francis Rose says:

    Trent, you have nailed it. The stock market is on sale. The best deal in investing right now is a total-US-market index fund. A year from now, you might not think so, but five years from now, 10 years from now, you will.

  5. Michael says:

    Trent, if your grocery store raised its prices, then lowered them again with a “sale”, you’d complain, not tell your friends to buy. You’d only buy if prices were reasonable before the hike. That is how you should look at the S&P 500 right now.

  6. Francis Rose says:

    @ Johanna: you don’t even have to buy stocks, or move money into the market. You’re already in the market, unless your 403(b) and IRA are invested in bond funds, money markets, or some other low risk, low return vehicle. You might want to review your options inside your 403(b) and IRA, move some of your money into total-market index funds, and then change your allocations so that future contributions go into those index funds.

  7. Susannah says:

    Johanna–you’re already buying, as you put money into your 403(b) and Roth. The point is that you shouldn’t hang onto that money or channel it into a money market fund just because the market is down. You should be doing little dances when you realize that your set contribution is buying more shares than ever before.

    Yes, moving a little money from bonds to stocks is possible, and it’s even recommended. You presumably have a target diversification percentage, right? 20% bonds, 80% stocks or whatever? If you look at the market right now, your stocks have shrunk as assets, so you may be unbalanced–for example, 25% bonds, 75% stocks. One of the hardest parts about long-term investing is to have the guts to say, “Hey, I need to rebalance,” sell what’s doing well, and buy what’s doing badly until you’re back to your 20/80.

    Remember, the idea with investments is to buy low and sell high. It’s not going to work if you’re too spooked to buy when the market’s down, or too entranced with your returns to sell high performers. And when the market is down, bonds tend to be high performers.

  8. Derffie says:

    Well anther approach would be to buy an equal amount of that vanguard fund that is down 10% … at todays lower prices and in effect cut your current % loss in half.. since the average cost of what you now own is only down 5% from the high of two months ago… a side benefit being it would only have to go back up .. 6% for you to be able to bail out totally from that inventment without suffering a loss

  9. tightwadfan says:

    Ughh. I invested a somewhat large windfall in 3 index funds in December. I’m wishing I’d waited until January. I’ve been through this before with my 401(k) in the post 9/11 slump so I know I just have to sit tight and ride it out. But it’s definitely painful to check my Vanguard account these days.

  10. GBlogger says:

    I share some of the thoughts by the previous commenters but think this is a great post for people who are spooked by the market — which is still a lot of people. Dollar cost averaging is probably a reasonably good strategy for some of the spooked people who don’t feel comfortable making individual decisions to try to buy low and sell high.

    I haven’t tracked exactly what we’re down since the beginning of the year and don’t like to pay too much attention to the market day to day. But I think we’re probably down about $40-45K on paper. I am pretty comfortable holding tight. We are also continuing to put money into the market in our retirement plans and other “automated” investing plans.

  11. ViralKing says:

    I agree 110%, a dropping market, in ANYTHING not just stock, is a time to BUY!

    I might go to USA next year to buy some property as I expect the RE market to bounce back too in the coming years.

  12. Well, I always hear the frase “don´t grab the falling knife” and right now looks like one of those moments. With your economy going to the shadow for a couple of years and trying to import all the possible inflation (cheaper debt, more exports) by devaluating the dollar, it doesn´t look like the best moment to enter in the stock market.

    It´s so confusing when some people tell you to cut the bleeding soon and other to keep it for the good times…

    But I love your blog, so keep it up.

    A spaniard in Slovakia.

  13. Penny Squeaker says:

    Trent,

    You are right, now that the market is dragging. I’ve invested a total of $4000 in Vanguard High Yeild Corp Bond between 1/08-3/5/08. It’s the lowest it’s being in years.

  14. Johanna says:

    Susannah, a 10% decline in stocks is not going to shift an 80/20 allocation to 72/25 – it will shift to more like 78/22. It would take a 25% decline in stocks to shift it to 75/25. That’s how math works. And besides, most experts don’t recommend rebalancing more often than about once a year.

    A down market is a time to buy – but no more so than any other time.

  15. jtimberman says:

    Despite the overall down market, my IRA funds are up. Marginally, about 4%, but thats about inflation.

    The key to mutual funds is finding one with a long track record for strong growth. I look for funds that have been open at least 15 years and have a 12-13% rate of return. The older the better.

  16. Yep, stocks are really on “sale” right now. I’ve picked up a few shares of my favorite companies.

  17. Kacper says:

    Hi Trent,

    I can’t 100% agree with you. Stocks are long term investment, only if you are a long term investor. In that case, I won’t sell stocks right now. This is correct. But I will not buy stocks right now. Why? Trend is your friend. Right now, stocks are going south.

    But if you are mid term or even short term investor, you should rather sell it. Actually, now it is little late, but better now than later. And yes, the price is important and enough factor to sell stocks. Especially, if you use technical analysis to determine when to open and when to close position.

    Of course, above is only my opinion and you are all responsible for your investment decisions.

    Have a nice day.

  18. Josh says:

    I have to disagree with you on this one. The monetary policy in this country is screwed up that the only place for these stocks to go is down. Every time the FED drops the interest rate and prints more money we the average person are losing money. The dollar has dropped 17% in the last 6 years. We are living in a fallacy land to think that the markets are going to rally. The banking crisis due to the housing bubble is only half way through and the second half is going to be the straw that break the economic back.

  19. KC says:

    Something people are overlooking right now are interest rates. I could park money in a money market at 4% interest right now (it’ll go lower if the Fed cuts rates). Or I could invest in a number of well-known, blue chip companies that are paying a high dividend rate due to their stock prices being undervalued. VZ, T, BBT, NLY, MO all pay dividends above 4% and are undervalued companies (meaning they are on sale). Money parked here should be long term money and not something that will be needed in less than 3 years.

    BTW, stocks don’t necessarily need to be thought of as long term holds. Its the MONEY in the stocks that is long term. If you buy a stock and it goes up 20% or more you should sell some for profit, especially if it changes the fundamental values of the stock. Its the money that is long term, not the individual stocks. I rarely hold stocks for more than 3 years, but the money I buy and sell them with is money I don’t need for at least 10 years.

  20. Credit says:

    This post still indicates that understanding of diversification is lacking. The Vanguard 500 is *not* diversified and will get hammered in a recession. I would advise that Trent and others please research other asset classes and understand that investing in a few large cap stocks like the Vanguard 500 is not a diversified portfolio. You need to hedge the economic contraction risks with other asset classes or you will lose money in the long term.

  21. rstlne says:

    In a taxable account, if I were showing a loss, I would sell and then buy something else to capture the capital loss deduction.

  22. Trent says:

    “Have you, Trent, moved money to stocks in response to the down market?”

    Yes.

    “If so, what were you doing with that money before?”

    It was in cash.

  23. Michael says:

    @rstine — The IRS may call this a wash sale and forbid your capital loss. See Pub 550.

  24. It’s hard (nay, impossible) to pick the bottom of the market.

    Trent is right: when stuff is on sale you buy.

    You have choices, too: you can buy stocks, real-estate, money – they are all cheap right now.

    In all cases, if you have a 20 – 30 year outlook, history virtually guarantees you a great outcome … it’s up to you to decide if this is the right market to take the same chance with (only) a 5 – 10 year outlook.

  25. Sam says:

    I disagree almost entirely, there are clearly some areas of the market that are way overheated such as energy and commodities and some are way undervalued such as Financials.

    So to make a blanket statement to “just keep” buying is a little bit deceiving and incorrect.

    You should be BUYING things that are on discount and SELLING things that are peaking.

    To use the grocery store example, you stock up on items that are CHEAP and skip the things that are expensive.

    Buying into an index fund is simply going to the grocery store and buying one of everything because everything averages out: low items average out with high items.

  26. chris says:

    it’s kind of annoying. back in october my stocks were up and i was ready to sell to move the money into savings to buy a house this year. of course i wanted to wait a few days and it just went downhill. I hit break even a few times since but i always decide to wait one more day and that next day is always a huge drop so i wait longer. Oh well, I’ll find the right time to sell, luckily house prices aren’t going up at the moment so in some ways i’m breaking even.

  27. Bear says:

    It always makes me a little sad when great personal finance sites like this one give investing advice. It’s just so often wrong. The era of buy and hold is coming to an end. Do you really think we are going to see exponential growth forever? Do you really think we are going to average 5.3% growth for the next hundred years, like we did from 1900-2000?

    Not even Warren Buffett thinks so, nowadays. He pointed out in his last meeting with shareholders that if we grew at that rate the Dow would be somewhere around 2 million. By investing in an index fund, that is what you are betting on.

    The fact is, the tremendous growth we have experienced over the last 30 years was built on the back of cheap credit, cheap energy (oil and coal), and cheap overseas labor. All of those things are coming to a halt.

    We are standing on the brink of change, and what we are seeing now with the markets tanking is just the tip of the iceberg. I sure wish you could point out some of those “doom and gloom” stories in the media, because all I see are people towing the party line: “Buy while it’s cheap!”

    Here’s a hint: things are going to get worse.

    Subprime resets are set to peak in July 08, so 6 months after that we may see a peak in foreclosures. All option ARM resets peak in 2011, so MAYBE housing prices will the hit bottom then. For the first time in the history of the US, banks have gone into the red on reserves, and are being forced to borrow money from the FED and overseas at loan shark rates in order to stay solvent. The dollar is tanking and the FED just keeps slashing rates to keep the ship floating.

    So, you go on and buy your index funds with your hold and pray mentality. If you think it’s a sure thing, just remember if you invested in 1929, it took until 1954 to earn your money back (not counting inflation). I hope you don’t plan on retiring anytime soon.

  28. luvleftovers says:

    I figure the only way I’d really lose (my 401K) is if I SELL now. I’m slowing edging my contributions up once a month. I’m waiting for a few funds to drop further and then I’ll increase my contributions to scoop ‘em up. I know in 10 years I’ll be happy that I did. My biggest concern is figuring out when they are near bottom enough to start scooping. I guess I just watch to see when they appear to be leveling.

    Let’s face it folks, real estate bounces back, even if it takes a while. Fortunately, I still have about 20 years to wait.

  29. partgypsy says:

    I am no stock expert, but of course been dutifully been putting my 10% (plus 5% matching) in my 401. It’s a lifetime fund which has a pretty good exposure to Intl funds (20%?). Here’s my view. I don’t like what greed and our fiscal policies have done to the stock market, but at the same time I can’t afford to stay out of the market if I ever want to retire. Warren Buffet’s predictions of 5% are if people are rational investors, which they are not. My view is the market will be depressed for next 2-3 years due to subprime mess, but there are far too many people with lots of money who want to make more money for the stock market to not be a player. After 2 or 3 years there will be some wild rides but I believe over time it still will beat bonds and money markets.
    In 20 years, once we do hit shortages, and are dealing with consequences from global warming, etc the bottom will fall out, and that’s when you do like Martha Stewart and retire to your nice self sufficient farm you built with your millions (Only half-kidding).

  30. Susannah says:

    Hey Johanna–it all depends. You mentioned you were younger so I assumed a fairly aggressive stock portfolio. But I had no intention of guessing your actual stock/bond ratio, recent losses, or allocation. I was using nice round numbers because I had no real info on your individual situation.

    You wanted to know where people get money to buy in down markets, and that is essentially the answer. They rebalance. Doesn’t mean you can or should or ought to–you said yourself that you have a plan and you’re dollar-cost averaging. If you remain essentially balanced in your asset allocation, it’s a mistake to change it in response to market conditions.

  31. Johanna says:

    Susannah: It sounds like we agree, then, but that we read different things into Trent’s post. To me, it seemed to be implying either that you should spontaneously change your plan in response to market swings, or that holding back money so that you can try to time the market should be part of your plan to begin with. And I don’t think either of those approaches is wise.

  32. GBlogger says:

    Bear makes a good point that double-digit returns are not likely going forward — but I think it’s over-reading Buffett’s letter not to buy index funds or not to be in the market (though I’m not sure both are meant by the comment). And even taking the gloomier “bearish” outlook, I bet there are lots of readers of this blog who ARE thirty plus years away from retirement…

  33. The whole point of his post is to let people see that they shouldn’t overreact to this dip, they should just stick to whatever strategy they had going in the first place. As for buying more than normal to buy “on sale,” that’s up to you. Just don’t sell.

  34. rstlne says:

    @Michael That’s why I specified to buy “something else”, i.e. not identical to what you’re selling. The wash sale rule only applies if you sell and then buy back the same stock. In the case of ETFs, even two similar-sounding ETFs could have stock components that are different enough to not fall under the wash sale rule, so you might be able to capture the capital loss by selling one and buying the other. Check under the hood before doing so.

    Alternatively, if you really do wish to get back into the same stock, you could also wait 31 days before buying it back.

  35. lorax says:

    Not that I can predict the future, but it wasn’t all that surprising that stocks went down. Everyone from John Bogle to Robert Shiller thought that the market was somewhat overvalued, the question was how long it would be before it sunk.

    Bogle (founder of Vanguard) actually went so far as to say that retirees should move a portion of their money into risk-free bonds.

  36. NED says:

    Trent,

    Much as I agree with the “buy when it’s low” axiom, I would like to caution against buying too much in this period. I think doing an indepth analysis of markets is a case of TMI (too much info), but the short story is that markets are taking a beating and will probably get more depressed before the expected upturn occurs.

    Translation: Prices are expected to drop further, but stocks and shares you own should increase in value before the year is out. Don’t sell what you own, buy stuff that you think are a bargain and always, always, always know what you are getting yourself into before throwing your hard-earned money away. Warren Buffett analyzes each purchase before he makes it, you should too.

  37. NED says:

    Iorax (comment #35),

    Typically, retirees should move more of their portfolio to risk-free investments as a rule of thumb. The reason can be summed up in 1 word: time.

    Retirees are living the last years of their life, so any potential risk of loss should be reduced because they simply cannot recover the amount lost. To put it crudely, they are going to die in the “sooner-than-average” future, so they should be taking steps to make sure that what they have saved up should be distributed evenly over the years, not lost in playing with electronic numbers on a lightboard.

  38. A Hayes says:

    I have a question–
    I have about $4000 in Vanguard’s European Index fund but I want greater diversification so I want to open a new account in Vanguard’s Total International Stock Index (which is composed of Vanguard’s European Index fund and some other funds). I need $3000 to open the new account so I was thinking of transferring that from the European Index fund, the price of which is down now and not likely to go up anytime soon. Would it be better to hold onto the European Index Fund or is it sound to get rid of most of it and open this new account? The price of the European Index is low but so it the price of the International Index.

    Any comments welcome! Thanks!

  39. Brad says:

    Trent, your comparison is lacking when you compare it to a grocery store. We don’t buy investments (or at least we shouldn’t) at the grocery store. We buy things we “need”. Thus getting a sale means a future expense will be lower (hopefully). Getting a stock when it seems down may or may not be good, depending on its future direction. The real question is what is the future direction of the market? What impact will past FED bloating and the housing market implosion have? That is the best question.

    It looks to me like learning enough to buy single family rental homes (3 bedroom/2 bath) would be a whole lot better in the long run than jumping deeper into this market. (One good location for less hype is http://www.johnschaub.com.)

    The market doesn’t look like a good place for the next few years, though I have no idea when the final results of all the FED printed money will ultimately hit.

    Brad

  40. Kyle says:

    Wow, there are a lot of negative comments here. I would say this is good advice. Remain diversified and ride it out.

  41. lorax says:

    @NED Good advice, but that wasn’t Bogle’s point. He said to move an EXTRA percentage of money into bonds (10% IIRC), for those tapping funds.

  42. wilson says:

    I’m no expert, but it would make more sense to buy when the market is improving rather than declining. You may miss gaining from the bottom, but you are avoiding having your money erased or waiting 30 years to recoup your losses. The economic problems with this country are serious. A terrorist attack (if we’re lucky) or an invasion (if McCain is) and things could get bad. People who bought at the beginning of the Depression didn’t do too well.

  43. Daft says:

    Bear (#27) I just wanted to thank you for that response. It’s nice to see someone else preaching the pragmatic reality.

    We are in spurious territory right now. Think of how different 1900-2000 has been, compared with 1500-1900. There is no reason – besides nostalgia – to believe that the reality of the next five, ten, twenty years will be based entirely upon our experiences over the last 100.

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