What To Do When The Stock Market Falls by Ben Reynolds
The stock market is down over 8% so far in 2016.
Source: Google Finance
Price declines have sparked widespread fear in financial markets that 2016 will be ‘the year of the bear’.
There are a myriad of reasons why the market has fallen in 2016:
- Fears of Federal Reserve interest rate increases
- Growth slowdown in China
- Plummeting oil prices
If you focus on negative short-term events the market looks bleak. The picture looks very different if you step back.
Notice the scale on the left-hand side of the image above is not linear. The stock market has exhibited exponential growth over long time periods.
“In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497.” – Warren Buffett
To take advantage of exponential growth you cannot sell when the market dips down.
There are steps to take when the market falls. This article examines what to do when the stock market falls. It also gives 3 examples of high quality dividend growth stocks that are currently trading at a discount to fair value.
What To Do When The Stock Market Falls
There is a fantastic story that beautifully sums up what to do when the market falls.
“A broker who kept a brick on his desk would tell his new clients, ‘one of these days the market will go down and you’ll be upset – maybe so upset you’ll want to throw this brick through my window. Before you decide to throw this brick through my window I want you to do one thing I want you to write a check to your mutual fund company and tie it to this brick, because when the market falls, you should be thinking about buying more shares.’”
Source: Storyselling for Financial Advisors, page 225
The story above is very clear. You should be buying, not selling, when market fall.
As a side note, replace ‘mutual fund’ with ‘high quality dividend growth stock’ in the story above. Mutual funds tend to have high fees which hurt individual investor returns over time.
Warren Buffett On What Do To During Market Declines
Warren Buffett has 3 cornerstones of sound investing. All 3 are concepts Buffett finds to be critical to investment returns.
His second cornerstone is to look at market fluctuations as your friend rather than your enemy. Click here to see Buffett’s other 2 cornerstones of sound investing.
When markets are falling people tend to panic.
Most investors (including many professionals) see market fluctuations as their enemy. It’s easy to understand why. The quoted value of your investments has gone down. You have lost money (at least on paper).
Two facts take all the sting out of market falls:
- You don’t have to sell because the market is down
- You do get the chance to buy great businesses at bargain prices
Since you don’t have to sell when market prices fall, why would you?
If someone offered to buy your car one day for $20,000 and you didn’t sell then why would you sell if they came back a month later and offered you $10,000?
When the stock market falls we treat our assets differently. We want to sell our shares in great businesses because people will pay us less. That doesn’t make any sense.
As a seller you want a higher price. When prices get low, just don’t sell – even if other people are.
On the flip side, being a buyer is great during market falls. You get the opportunity to buy high quality businesses at a discount.
Think of market falls as coupons for 10%, 20%, 50%, or even more on ownership in great businesses.
“Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down” – Warren Buffett
Market falls give you the opportunity to buy ‘high quality merchandise’ (high quality dividend growth stocks) at reduced prices. What could be better for compounding your long term wealth than that?
You have the opportunity to benefit from market fluctuations by purchasing great businesses when they go on sale, and only selling them when they become very overvalued.
“Be fearful when others are greedy and greedy only when others are fearful.” – Warren Buffett
The 8 Rules of Dividend Investing are designed to help investors take advantage of market fluctuations and build a portfolio of high quality dividend growth stocks.
Warren Buffett does not just talk about holding through recessions. He actually does it. This is best exemplified by Buffett’s investment in American Express (AXP).
Buffett first invested in American Express in 1964. He has held the stock for over 50 years. A lot has happened in those 50 years. The market has seen exponential growth – and severe corrections. Buffett held through all of it.
Warren Buffett is not the only investing great with wisdom on what to do when the market falls
Other Investing Greats' Wisdom on Stock Market Falls
Warren Buffett is the most famous investor alive today, but he does not have a monopoly on good investing advice.
Peter Lynch and Seth Klarman both have important takes on handling market declines.
Here’s what Peter Lynch has to say about market declines:
“You get recessions, you have stock market declines. If you don’t understand that’s going to happen then you’re not ready, you won’t do well in the markets.” – Peter Lynch
The market’s long term trajectory is upward. It does not go up in straight line, however. If you invest in the stock market you will experience market declines.
You must be prepared for them. Peter Lynch’s advice is to understand that markets will fall while you are invested. Coming to peace with this fact is critical for long-term investing success.
Humans in general (myself included – and you too) have a natural tendency to overreact to both positive and negative news.
This creates market bubbles and collapses. We hear good news and we overweight it. We hear bad news and we think the sky is falling and the S&P 500 could hit 0!
Seth Klarman (the billionaire hedge fund manager of Baupost Group) understands this very well.
“The stock market is the story of cycles and of the human behavior that is responsible for overreactions in both directions” – Seth Klarman
The act of knowing that we are predisposed to over-reaction can help us prevent it from occurring. Investing is very much a calm man/woman’s sport. You must separate yourself from your emotions and behavioral biases if you want a chance of doing well.
Watch Dividends Not Stock Prices
I believe that a good portion of the short run focus in the market is a result of investors paying attention to the wrong metrics.
Instead of worrying if a company will miss analyst expectations by a few pennies (does this really even matter?), why don’t we focus on how a business is expected to grow over the decade?
Price fluctuations tell us