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.)