So, this blog post is, hopefully, going to explain why/how the stock market reacts to things- and why actually, a drop of 5% is a good thing.
Table of Contents
I’m new to investing- and don’t want to lose money
I see this comment a lot- both online, and with friends etc. Firstly- investing is not for everybody, and if you need the money within the next 5 years- its almost definitely NOT for you. This is because stock markets can move large percentages, very quickly- and if you need the money at that particular moment in time, you could be selling at a loss. So, if you really don’t want to lose any of your capital, then stock investing is not for you. If on the other hand, you can get over the human emotion of loss, and won’t check your stocks every day- then maybe investing is for you.
Why Stocks down 5% is actually a good thing
Until you get to a point in your life that you are starting to sell your stocks and require the money (think, retirement), stocks going down in price is a good thing. Hold on, are you really saying that having an asset that is worth less today than yesterday is a good thing? Well, basically, yes- as long as you are still in your accumulation phase, it’s a really good thing. An example if you will:
You currently own 100 stocks of, “white shiny things ltd”- currently each worth £10, so a total investment of £1,000. This week, their financial results came out, and weren’t as good as expected, the stock price dropped 5%- to £9.50 each. Your investment is now “only” worth, £950- a paper loss of £50. Now, I call this a paper loss, because, you still own exactly the same amount of stock- 100. So, what do you do? Well, as part of your monthly investment, you buy another 21 stock, because that’s the amount you normally invest (£200). Now, last month, you only got 20 stock for your £200- but now you get slightly more. So month 2 rolls around, and the stock price has returned back to it’s £10 a stock level, but now, you don’t just have £1,200 worth, because you managed to pick some of it “on offer”, you got an extra share, so your total is £1,210.
So, the cheaper a stock (or index of stocks) is, the better it is for the long term investor. As long as you can keep the path, and aren’t going to sell when the stock price is lower than you want- it will go back up, it’s only a question of when.
So, only buy stocks on offer?
Well- this would be the ideal world, every stock that you wanted to buy was on offer, and then (when you have finished buying as much as you wanted) they then went up in price. Unfortunately, this is pretty much impossible- so anybody that tells you that they can predict this is lying. So, what does that mean for you? Well, you should be index investing for a start, so, it really shouldn’t
Time in the market, over timing the market
I don’t know if you have heard this saying before, but if you haven’t, repeat it to yourself a few times. It makes perfect sense- there is no point in trying to time the market, as you will just fail. Many many people, companies, investment funds try and do this (and in fact, take a look at any active fund for their mission statement). And guess what? Most of them fail, especially over the long term. And they charge you insane fees for trying as well! Instead, find the index you want to track, and find the cheapest fund that does this with the lowest index error.
Index funds over individual stocks
I’ve said this time and time again (and within this post as well), but this really only applies to index funds. Whilst individual stocks can make huge profits- they can also make huge losses (in, fact, all the way to zero!) Index funds can pretty much never do this- they can lose huge chunks of their value- we only need to look at the tech bubble burst of 2000, or the credit crisis of 2007/2008. But, within a few years, they were back to levels just before the crisis. Whilst if you held shares in companies that went bankrupt, you would have worthless paper.
None of this is advice!
As I say in my disclaimer, none of this is advice. If you want that, you should go and find an independent financial adviser (IFA) who has the appropriate qualifications and will be regulated to ensure the advise provided is correct.