Beginners take their money and run
At the first sign of market jitters, many inexperienced investors take their money and run for the hills. It's easy to see why. When you think you may lose money, you just want to cut your losses rather than ride out whatever the markets do next.
The biggest problem with this strategy is that most beginners don't sell until it's already too late. If you sell after a big drop in the market, you broke a fundamental rule of investing: Buy low and sell high. By selling low, you lock a loss into your portfolio that may never recover.
Buy Low, Sell High, Not the Other Way Around. (Source: BigCharts; notations by author)
To further the pain of selling at the wrong time, most investors, beginners and experts alike, can't accurately spot the bottom of the market. Because they sold when stocks were down and didn't rebuy, they won't get the benefit when prices eventually rebound and climb to new highs in the future.
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Experienced investors see an opportunity to buy stocks at a discount
Experienced investors know an important trend in stock market history. Historically, every time the market tumbles, it comes back with a vengeance. The market has always done more than recover. Each recovery has led to big gains and new highs for stock prices.
Because long-term market trends have always gone up, experienced investors look at big drops in the market as an opportunity to buy even more.
Buy More When Price Is Low. (Source: BigCharts; notations by author)
It's nearly impossible to time the markets and guess the exact top and bottom. Even full-time investment fund managers underperform market benchmarks most of the time. People who went to Harvard and MIT spend long days on Wall Street trying to beat the market and can't do it most of the time. So why do we think we can when we're doing it just part time?
Over any long period of time, the S&P 500 has returned around 10% per year. If you buy when stocks are low, you are in a better position to capitalize on that long-term trend.
S&P 500 Chart 1978 to 2019 (Source: BigCharts)
Big stock market drops and volatility can be scary, but the power of the U.S. economy has always turned every bear market, recession and depression around with new highs in just 5 to 10 years.
Of course, past performance is no guarantee of future performance. But history has a tendency of repeating itself, and experienced investors often win big by buying when others are selling.
What kinds of stocks can you buy?
When the stock market falls, there are a few different moves to make if you are looking to buy. These include investing in broad stock market index funds or choosing individual stocks you think will perform well through the stock market crisis and beyond. While each crisis is different, there are a few sectors to keep in mind during the current coronavirus pandemic.
- Behavioral investing: In the current coronavirus crisis, delivery services, grocery stores, big-box retailers, consumer staples, online work and digital entertainment companies may fare well. Think of the companies everyone is using when locked in their homes. Those are the ones that are likely to outperform when the rest of the stock market suffers.
- Blue-chip investing: Blue chip stocks are large companies with a strong balance sheet. These titans of industry and pillars of the economy generally outlive short-term market volatility and provide steady, reliable long-term gains. Companies you have heard of like 3M, Ford, Disney, McDonald's and Walmart are often the best investments during a stock market crash.
- Small-cap investing: Smaller companies with lower market capitalizations have more opportunities for rapid growth than bigger blue-chip stocks. However, smaller stocks are likely more volatile and carry more risk compared to their larger counterparts.
- Index investing: Most actively managed funds underperform compared to the overall market. So you may want to just buy into the overall market. You can do so with index funds, ideally with a very low fee. If you can't beat the market, you may as well buy the market! The majority of my own portfolio remains in an array of low-fee index funds.
What can you do to learn from the bigger investors?
Famous investors like Warren Buffett often share exactly what they are doing when the market goes haywire. In fact, Buffett put his investment strategy bluntly when asked how he manages the massive investment portfolio of Berkshire Hathaway:
We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.
During the Financial Crisis of 2007–2008, Buffett made a fortune investing in distressed companies. While most of us can't offer a multi-billion-dollar credit line to banks in exchange for preferred stock, we may still be able to get a good deal following Buffett's advice.
For example, when bank stocks fell amid the breakdown in mortgage markets, smart investors could have followed Buffett's example and invested in companies like Goldman Sachs and Bank of America. In March 2009, you could buy Bank of America stock for less than $3 per share. At the end of 2019, those shares were worth more $35 each. That's a return of 12 times over a decade. In November 2008, Goldman Sachs went for less than $50. In January 2020, the price topped out at over $250 per share. That's a return of more than five times.
Distressed stocks today include those in the travel and entertainment industries. Airlines and hotels have been hit hard by the virus. Airline stocks are down sharply as flights have been canceled and revenues plummet. The stock of concert promoter and ticket seller LiveNation dropped by more than 50% as events have been canceled around the world. If these companies can weather the storm, they could be bargain-priced today.
5 investment tips for beginners from experienced investors
1. Invest in strong companies
You should invest in a company only if you believe it will be around for the long term. Investing in penny stocks is akin to gambling, as is day trading where you try to earn a profit from market volatility. Investing in blue chips and similarly strong companies with a healthy balance sheet may not be exciting, but it is a reliable way of building a solid portfolio that can outlast recessions and stock market crises.
2. Keep a long-term focus
Short-term volatility in the markets at the start of the coronavirus crisis is enough to make anyone feel unsettled. The largest stock market one-day drop in history occurred March 16, 2020. But the biggest daily gain of all time was just eight days later, on March 24. As of March 24, 2020, all five of the largest one-day drops have been amid the 2020 stock market crash. And all five of the largest one-day gains have been during this same time.
The noise of daily market movement can distract you from longer-term goals like retirement. Unless you are nearing the age where you'll need to tap into investments for living expenses, you should focus on when you will actually need the funds.
3. Set up an automatic investing plan
Savvy investors set up their portfolios so they can invest without even thinking about it. Automatic investment plans and automated transfers can help you make the most of your portfolio. Some investors call this strategy dollar-cost averaging, as you buy a set amount regularly. This averages the price over time instead of making one big purchase. If you have a 401(k) plan or similar retirement plan at work, it is a perfect place to use an automatic investment strategy.
4. Don't buy or sell on a whim
Hot stock tips sound great, but they don't always work out the way you plan. Buying or selling on a whim can be a costly mistake. Outside of regular, automated investing, it's a good idea to do some analysis before making an investment decision. Fundamental analysis is a good way to decide if a company is worth buying or selling. Technical analysis uses recent market activity to help decide if a stock is going up or down.
5. Keep emotions out of investing
When you see your stock portfolio quickly drop in value, your gut instinct may tell you to sell before it drops even more. If that's the case, put your instincts aside and listen to your head. If you follow your emotions, you're likely to buy high and sell low. You might sell when the drop is nearing its end. And you might buy back a stock too late after missing a rally. Don't let your emotions dictate how you invest your money. Focus on the numbers and you'll likely find better results.
Learn from the experts
Stock market drops may give your stomach the same feeling as a rollercoaster. But unlike the big drops at a theme park, big drops in your stock market account are no fun at all. With a long-term focus and smart investing strategy, beginner investors can find big success in the stock market.
If you want to take advantage of the current market lows, now is the time to do so. Find a financial advisor like Fisher Investments or open up a brokerage account at a financial institution like TD Ameritrade
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