In 2021, we’ve already seen some incredible highs, as well as (more recently) some great lows. While many people may be panicking when the market takes a hit, we as cheapskates see this as an opportunity because like we’ve said before, money isn’t made in a bull market, its made in a crash. With the dark clouds looming and the talk of bubbles bursting, we’re going to talk about some of the reasons to invest during a market downturn and some of the tips and tricks we use to make the most out of it
As always, the following is not financial advice, read our disclaimer
“Be fearful when others are greedy, be greedy when others are fearful”– Warren Buffett
Why to invest during a crash – The history
So, it might seem obvious that investing when prices are low is a great strategy. After all, we’ve all heard the mantra “buy low sell high”. But hold up, some of you may be thinking “what if the price of a stock never recovers? What if the market keeps going down?”. These are valid concerns and it’s easy to think like this when you’re losing money – most people do, which is why a lot of people lose money in the stock market and kind of why the price of stocks fall in the first place. It’s a a little like dominoes – when one person sells, the price dips a little, making more people sell to try and cut their losses, which makes more people sell… you get the picture. And before we get into it – Full disclosure – the market COULD keep going down and never recover, though that is highly unlikely and we’ll explain why.
We at cheapskate like to use data to influence our decision making. The best data we have on how stocks might rise and fall over time, is to look at what its done in the past. The graphic below shows how the performance of the S&P500 over the last 90 years, which is the standard for measuring the performance of the US stock market (the same principles applies to the UK market too).
As you can see, although the chart shows peaks and troughs (you can see the great depression in 1927, black Monday in 1987, the dot com bubble crash in 2001 and the housing market crash in 2008), the overall trend is upward. Each and every time the market has crashed, it’s come back even stronger. What’s more, is what would happen if you invested DURING those crashes? We’ll come onto that shortly.
Long bulls and short bears
No doubt you’ve heard of the terms bull and bear markets – they are part of the life cycle of the stock market and periods that as an investor you’ll have to live through. There’s some good news to be found here though.
What are bull and bear markets?
In short, a bear market is when the stock price of a major market index (think S&P500 and FTSE 100) decline by at least 20% from their high (note – a correction, which you will hear as another term to describe a market downturn, is characterised by a fall of 10%). Sometimes, a bear market can signal a coming recession, where investors are pessimistic about the future of stocks and drive the price down by selling their stocks. This is usually accompanied by rising unemployment among other things.
In contrast, a bull market is triggered when stock prices of indexes rise more than 20% from their lows as a result of an inflow of cash into the stock market and a rising economy.
So what’s the good news?
The good news is that historically bull markets last far longer than bear markets and the highs are much higher than the lows. The average bear market lasts around 10 months and hits an average of – 37.5%. Bull markets in contrast have lasted on average 2.5 years and hit an average of +112%.
This means that as long as you are investing long enough to weather a bear market and are prepared to wait, history tells us that the inevitable bull market will rise even higher.
The only bad news is that these bear markets have a smaller window for you to pick up low prices, which is why its important to have a strategy in place when they do hit.
Below, we list some of the things we do during a market downturn
1 – DO have a war chest
One of the worst thing that can happen to us as investors is have the investment of a lifetime come up and have no cash at all to take advantage. You might think you can liquidate some other stocks to take advantage of it, but remember, we’re would be in a bear market so the price will likely be depressed.
What we like to do as cheapskates is have some cash put aside ready for these scenarios. It might seem counterproductive having a load of cash sitting on the sidelines waiting for a bear market that never comes. However in our experience, opportunities come along all of the time so it’s worth having a pot you can use to take advantage.
What we do – in one of our previous articles HERE, we talked about having an emergency fund. We usually keep an emergency fund of say 9 months worth of expenses when in a bear market, but will be prepared to drain this to 3 months worth if an opportunity comes along.
2 – DO HODL
OK, the term HODL is usually associated with cryptocurrency, but has become synonymous with not selling your investments even through items of adversity.
It can be tempting to want to protect your money when a stock starts to fall (and remember, if you are close to retirement or a company is in free fall for other reasons than a downturn then holding may not always be the best option), but by selling you are 1 – contributing to the decline of that stock price and 2 – locking in losses. When a price is falling, you won’t get a better price than the current low price so we say don’t sell. Hold onto that stock and ride it out.
3 – DO bring you average buy price down
In the scenario above where a stock is falling, it can be disheartening to think that it might take months, even years to even break even and get back to where the price was before the crash. Here’s another sobering example – if you had bought Microsoft during the height of the dot com boom, it would have taken you 14 years just to break even after the crash!
But there’s a way to cut the time it takes to recover your losses. KEEP BUYING. For example, let’s say you buy 1 share of a company for £1000 and a few months later that stock falls to £500. Instead of selling that stock and locking in that £500 loss, you could buy another share. Now, your average buy price is £750, meaning the price only needs to climb 50% for you to be back in the green, rather than the 100% it would have taken had you not bought the extra share.
4 – DO still conduct fundamental analysis.
This can be an easy trap to fall into, however in a market crash, a bad company is still a bad company. Sometimes, an overpriced company can see huge losses during a market crash (think tesla right now) making the price from its high look very attractive indeed.
But remember, the price is probably going to be similar to what it was before, relative to the rest of the market because we’re in downturn.
We say even in a bear market its important to still research the companies you’re investing in and to make sure its a sound investment and has good prospects.
*Top tip, not sure what companies are good, we say in a downturn, invest in ETFs and index funds to capitalise on their rare cheaper prices. Read our beginner articles on ETFs HERE
5 – DO remember that you can’t time things perfectly.
When the market is in free fall, it’s difficult to put your money on the line as sometimes the Outlook. Can be bleak and there’s a good chance prices could go even lower. It’s easy to want to wait for the bottom but that would be a BAD idea.
It can be notoriously difficult to time the market (most professionals can’t even beat the average) so we say take timing out of it.
At cheapskate, we like to invest when prices take a hit, and keep investing as the price goes down. While it can feel like throwing good money after bad and almost guarantees we won’t get the absolute lowest price, it guarantees that we will still get a price well below market value and we won’t miss the eventual rebound, which we feel is far more important.
To illustrate this, let’s take a look at the chart below which shows us the return on $10,000 invested in the S&P500 over 40 years.
The results are staggering. If you missed just the 50 best performing days over 40 years, your return would have reduced by more than 93%. Do you trust yourself to pick the best 50 days over 40 years? We certainly don’t! Also note – the majority of these best days came during significant market downturns!
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