What the Stock Market Decline Means for You

You might have noticed that the U.S. stock markets took a tumble today. In fact, the drop was the largest in five years. What does this stock market correction mean to the average investor? What does it mean for the fellow who's just plugging a few hundred dollars a month into his IRA?

In the grand scheme of things, it doesn't mean much. The slow, sure path to investment success is to “buy and hold” your stocks. When you apply this strategy with discipline, then market fluctuations — even large swings such as happened today — are irrelevant. You're in it for the long haul. It doesn't matter what happens in the short term.

On the other hand, there's always some market timing involved with investments. Here's an example: I had planned to stick a few hundred dollars into my Sharebuilder IRA next Tuesday. Because of the way Sharebuilder works, this trade would only cost me $4. However, now it's tempting to make an unscheduled investment tomorrow. Market orders cost more with my plan ($15.95), but it's possible that this $11.95 difference could be made up shortly. (Ad: Buy Stocks for $4 at ShareBuilder.)

By way of example, UPS — the stock in which I intend to invest — is currently trading at $70.11. Let's say I put $500 into it, purchasing 7.07 shares of stock. UPS would need to be trading at $71.80 per share next Tuesday for this to be the correct move. The question becomes: how likely is this to happen?

What do the experts say? In “Today's selloff: Buy, sell, or hold?” at CNNMoney, experts offer differing opinions. One says, “You have to look at days like this as an opportunity.” He says to buy. “Nothing has changed fundamentally.”

But another expert says, “Stocks are not as expensive as they were at the peak of the bubble in 2000, but they are not cheap. …I'd be pretty cautious here.”

A third professional investor says, “Any pullback will be more of a buying opportunity than an indication of more to come on the downside.”

“Survive a market drop — and make it work for you”, another CNNMoney article, also recommends that investors stay the course. In fact, the article suggests that its better not to pay attention to financial news at all!

In the late 1980s, Paul Andreassen, a psychologist then at Harvard University, conducted a series of laboratory experiments to determine how investors respond to financial news. He found that people who pay close attention to news updates actually earn lower returns than people who seldom follow the news. When you think about this a little more, it actually makes good sense. News coverage tends to make market movements seem even bigger than they are — and to make them seem likely to persist just when they are most likely to reverse.

What it boils down to is this: nobody knows what today's sharp drop means. Nobody ever knows what's going to happen with the stock market. I believe the best bet for the average investor is to just sit back, relax, and remember that investing in the stock market is a long-term proposition.

(Note: As I write this, markets in Australia and Asia are continuing to decline, which probably means another drop in the U.S. markets tomorrow. I'll wait to buy UPS on Tuesday.)

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Anita
Anita
13 years ago

Hope this is not the start of a larger bear market. Many of the markets are still strong.

Dax Desai
Dax Desai
13 years ago

We should have some volatility in the morning, but I will be picking up 25% of my target stocks tomorrow: eBay (EBAY), Cisco (CSCO), and Goldman Sachs (GS).

I suggest going back in at a lower price point below your first. The volatility may give you another buying opportunity. Buy on dips. I think this is a god-send buying opportunity to pick up some quality stocks.

Dow Down 400 points: Why You Shouldn’t Care

James Kew
James Kew
13 years ago

It feel, what, all of 3%? That’s not a tumble; that’s not even much of a decline; in the big picture, it’s a blip. The sky is *not* falling. What does it mean to me? Well, mostly it means that Thursday’s 401(k) contribution will buy me a few more units. Nice. Cue the Buffet hamburger analogy. (It also means my 401(k) is worth a little less than it was the day before. But what’s a day and a few percent worth worrying about given a 35-year horizon?) On the other hand, there’s always some market timing involved with investments. Well,… Read more »

Cap
Cap
13 years ago

looks like market will be on sale for the next few days. I may be an optimistic (or just plain stupid) but yes, that includes emerging market funds too.

in fact that may be over soon as futures indicate. I sure hope not, because I’m waiting for funds to clear to pick up some discount.

Carter Adler
Carter Adler
13 years ago

You quoted three “experts” from CNNMoney as saying: One says, “You have to look at days like this as an opportunity.” He says to buy. “Nothing has changed fundamentally.” But another expert says, “Stocks are not as expensive as they were at the peak of the bubble in 2000, but they are not cheap. …I’d be pretty cautious here.” A third professional investor says, “Any pullback will be more of a buying opportunity than an indication of more to come on the downside.” This is like the blind men feeling different parts of the elephant. I suggest that all three… Read more »

Roy
Roy
13 years ago

The stock market being up one day and down the next, that’s just nonsense. It’s the long term that counts. Read Warren Buffet. He’s not infallable but he does come close. He predicted the rising cost of energy and the weakness of the dollar. What you want to look at, when buying a stock or a mutual fund, is how it did the last five years or more. Also do research. Read up on company, if it’s a retailer, go take a walk in the stores. Walking through Walmart vs Target, you can see which one is the better buy.… Read more »

Joe
Joe
13 years ago

I actually did this with JNJ awhile back. They had released some bad news about one of their products being stalled in FDA approval and their stock price dropped by a lot. You could tell that it was an overreaction and that it was now selling at a big discount. I had an order into Sharebuilder for the next week and then thought that buying immediately was a better choice. I finally decided to buy half immediately, paying 15.95 commision and the other half at the regular Tuesday buy, paying 4.00 commision. By the next Tuesday, JNJ was down another… Read more »

squished18
squished18
13 years ago

“What it boils down to is this: nobody knows what today’s sharp drop means. Nobody ever knows what’s going to happen with the stock market. I believe the best bet for the average investor is to just sit back, relax, and remember that investing in the stock market is a long-term proposition.”

Thanks for the reminder!

W.C. Varones
W.C. Varones
13 years ago

J.D.- This is a great illustration of why transaction costs are so important. By using a market order, you’re paying $2.23 over the actual stock price — or more than 3%. The normal transaction fee of $4 is much better, but still almost 1% on $500. Every percent counts, especially in an era of expected mid-single-digit returns for most asset classes. For this reason, I generally suggest stock trades only for larger amounts ($9.95 or $15.95 is a much smaller percentage if you trade only when you have saved up $5000). For periodic investing, I recommend using ultra-low-expense, no-load mutual… Read more »

J.D.
J.D.
13 years ago

This is like the blind men feeling different parts of the elephant.

EXACTLY!

W.C. Varones
W.C. Varones
13 years ago

Oops — almost forgot my original point:

By choosing the $15.95 now rather than the $4 next week, you’re paying an extra $1.70 per share.

That’s essentially an option premium. You are betting that the stock will be over $71.80 by Tuesday.

The options market can give you guidance on this. You can buy a March 70 call for $1.50, which means the market doesn’t expect the stock to be over $71.50 by mid-March, much less $71.80 by next Tuesday.

So the numbers would argue strongly against paying the extra transaction fee.

Ralph
Ralph
13 years ago

J.D.,

It’s refreshing to hear some common sense after having to watch yesterdays obscene display of the most embarrasing aspects of human and crowd behavior at its worst -hysterical, irrational and overreactive.

Fortunately, this is the exact recipe that allows level headed traders to profit massively from mass stupidity. I imagine there will be some unreal buying opportunities in a few days.

Time to make a shopping list…

Cheers,
Ralph
http://www.successfulonlinetrading.com/

Tinyhands
Tinyhands
13 years ago

There’s plenty of research out there on why market timing (for long term investors) is a bad idea. A number of studies point out that if an investor sat out the 10 best trading days over a 10 year span he missed out on an average annual return of nearly 5%. This implies it’s better to invest and stay invested. It also implies that if the volatility of a particular stock (UPS, in this case) is such that you’re willing to sit it out and attempt to second-guess the market, maybe there’s too much risk associated with this particular stock… Read more »

James Kew
James Kew
13 years ago

#9 makes a good point: you can’t control the market, but you can control your costs. $12 on “a few hundred dollars” is quite a heavy upfront load; the sort of load that most investors balk at on mutual funds.

And J.D., hadn’t you arrived at a realization that index funds were the way to go for you? Is there a bit of a head-vs-heart struggle here — the sensible-but-safe index fund vs the go-on-let’s-have-a-punt lure of individual stocks?

Brian Restuccia
Brian Restuccia
13 years ago

“Of yesterday’s top price losers by percentage, four of the top five are Chinese, and the fifth is South African.” That is because this entire sell off was sparked by a move towards more regulation in China. There has been concern for a while about the ‘too quick and easy’ growth in China backed by sub-prime loans and the way that capital is being thrown around. The Chinese government made it harder for people to get at this capital, meaning that growth should slow a bit. But that is better than explosive unsustainable growth resulting in a crash. This isn’t… Read more »

Ralph
Ralph
13 years ago

yes, and apparently the Chinese congress meeting next week is the big event the market is waiting for, we don’t expect anything decisive from the markets until then..

in the meantime, some very good stocks will likely get cheaper or remain on sale

J.D.
J.D.
13 years ago

And J.D., hadn’t you arrived at a realization that index funds were the way to go for you? Is there a bit of a head-vs-heart struggle here – the sensible-but-safe index fund vs the go-on-let’s-have-a-punt lure of individual stocks?

This is absolutely what is going on, especially after big declines. This is a case of hearing all of the advice, and intellectually knowing what I ought to do, but being wrapped up in the emotional “I can do better” thinking. That’s a way to “get poor slowly” or to “maintain the status quo”, eh? 🙁

Michelle
Michelle
13 years ago

Why aren’t any of you guys using Zecco.com for free trades?? For people who are willing to do anything to save a buck, I just don’t get it! It’s not like your money will disappear if Zecco goes under or anything! Do some research!

I happened to have $500 in my cash account yesterday at Zecco (earning interest), so I threw it all in there on one of my index ETFs that took a big hit. Totally free.

You guys are boggling my mind with this refusal to accept free trades!

James Kew
James Kew
13 years ago

To be honest, Michelle: I don’t trust Zecco yet. They’re brand new and unknown; I don’t know if their business model is sustainable.

They’re free now, yes. But what happens if, in a year’s time, they introduce an account maintenance fee? Or high fees for selling or transferring stocks?

All power to them, but for now I’ll wait and see. Sometimes it’s better to *not* be an early adopter.

“(earning interest)”

(At 1%.)

RonenV
RonenV
13 years ago

J.D., I agree with the vast majority of your article. My only question is why you are not taking your argument to its logical conclusion: i.e. timing the market is pretty close to impossible, but picking stocks that on average out-perform their respective market peers is also pretty close to impossible.

There is a large and well established body of research that demonstrates that when you take trading costs and other fees into consideration, index fund investing will generate higher returns than stock picking for a majority of investors.

Tom Clouser
Tom Clouser
12 years ago

All great comments! Sharebuilder does offer 6 free trades per month if purchasing the $12/month account. Definitely invest “long-term”, but that is a relative statement. I prefer to invest until a stock at least doubles. That might be 10 years, or only 2 months. Sell off half, and you’re home free. Use the money to invest in another stock. Invest at least $320 in one stock so that a $16 real-time trade only represents 5% of expense. Once stock is up 10%, commissions are covered. (5% on buying end, 5% on selling end). ETF’s make LESS money than well-researched common… Read more »

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