Another way to view the market downturn

The Simple Dollar chronicles a man's road to recovery from "total financial meltdown." As author Trent Hamm puts it, "The Simple Dollar is a blog for those of us who need both cents and sense: people fighting debt and bad spending habits while building a financially secure future and still affording a latte or two." We'll post a couple of entries a week, but you can check out his writing daily at www.thesimpledollar.com.


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.


Check out more of Trent's financial commentary at www.thesimpledollar.com, or learn more about him at www.thesimpledollar.com/about/.

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