There is a theory on Wall Street that goes something like this: If you follow the crowd and buy the hot investment of the day, chances are you’ll be scooping up shares when most others are about to sell. This natural tendency to buy when everyone is euphoric can have you buying at the wrong time and not buying when you should.
Investors often jump into an investment at the wrong time because they are worried about what others are doing, instead of focusing on good old-fashioned fundamentals such as the company’s earning potential or its management.
History has continually shown us that when individuals make investments without the prudent basis for doing so, they often wind up losing money that can take many years to recover. We saw this in 1998-2000, when investors drove the Nasdaq composite over 5000 — only to see it fall to less than 2000 the following year.
History has also shown that when individuals avoid investments because the popular thinking is to steer clear of them, opportunities are often overlooked. We saw this in 1982, when interest rates were high and companies had a difficult time impressing analysts with their earning potential. That period proved to be the beginning of a bull market that lasted more than 15 yrs.
On October 19, 1987 the Dow Jones Industrial Average fell 22% in one trading session, the worst trading day since October 1929. However, that day brought tremendous buying opportunity. Despite that decline to 1738 points, the Dow closed at 10,159 on March 31, 2001 — for an annualized growth rate of 13.97%.
At the end of 1994, a year in which stock and bond markets both struggled because of the higher interest rates, the common thinking was that 1995 was a bad year for the financial markets. If you took that advice, you would have missed out on one of the stock market’s best years.
In response to market downturns, some investors shift a greater percentage of their assets to money market funds. Time and time again, this strategy has proven to be a mistake.
Keep in mind that the stock market has experienced nearly twice as many bullish periods as bearish periods over time.
When times get tough for stocks, maintain your confidence in their long-term growth potential and use these simple strategies:
■ Reduce your cost by averaging down. If one of your stocks declines in value, but the underlying business is still sound, consider buying more shares. You will reduce your overall cost basis.
■ Stay diversified. Keep your assets spread among investments likely to perform differently under the same market conditions. Profits from appreciated investments will help offset losses from any losing investments.
■ Stay focused on your long-term goal. Don’t try to avoid the downturn by jumping out of the market. No one can accurately predict when it will rebound.
When considering investing, seek professional advice.
Ellis Liddell is president of ELE Wealth Management, LLC in Southfield, Michigan. He is also the author of “Wealth Management: Merging Faith with Finance.” He can be reached at (248) 356-6555 or through his website: www.elewealth.com.