With gas prices soaring to over $5.00 a gallon, the cost of groceries on the rise, and a recession looming, what do you do? First, don’t panic. That is exactly what gets many people into financial trouble. Let’s walk through this together, so you may gain a sense of understanding and, hopefully, the resolve you will need to make wise decisions with your money.
Let’s go back to the idea of a recession, but we will add in investments. Let’s look at a typical S&P Index Fund such as an S&P 500 index fund like the Vanguard 500 Index Fund ($VFIAX) which is currently down. For ease of math, we will say it costs $500 per share. If you were to buy one share every two weeks for two months at that cost, you would have accumulated four shares, costing you $2000.00.
But THEN, we will say that the market dips like it is doing right now. If the market drops twenty percent, the share will go from $500.00 to $400.00. You just lost money which, depending on how far out from retirement you are, is upsetting to catastrophic on the panic scale. Regardless, you are not very happy at this news and turn of events.
However, if you do not do anything, holding onto the four shares that you have, and previously setting up automated investments, you still own four shares and are slated to buy more. Week ten is around the corner, and you are automated to purchase another $500.00 of the same Vanguard 500 Index Fund ($VFIAX). But you also realize that there is a sale on this same stock at 20%. Good for you from a purchasing perspective! This means that now instead of getting one share, since you are already automatically spending $500.00, you will actually get 1.25 shares of the stock. So now in your portfolio, after week ten’s automated purchase, you will have 5.25 shares, thus increasing your shares.
Going further with our recession scenario, let’s say the market continues to struggle for an entire year. Who knows, right! The news continues to predict soaring prices, an even bigger dip in the economy, higher interest rates, and all of the other “gloom and doom” information we are currently hearing and reading. Everyone is predicting financial collapse. People are selling and pulling their money out of the market. Analysts are advising to have cash on hand and some are liquidating everything. But you continue to ride it out. In fact, your investments are automated, so you continue to buy. You do not panic, knowing that you can’t play the market or “Time the Market.” The market will eventually correct itself. Some people who understand this just chose not to look at the bottom line during such times, realizing it is just at a low and will rebound.
Finishing our recession scenario, let’s say after about a year, the economy begins to take an uptick. Prices settle and people relax; many begin to spend and stimulate the economy even more. There are fewer and fewer news stories about the collapse of the economy. There will still be stories since tragedy is what sells the news. Nonetheless, now people, many who tried to persuade you to sell a year ago and to hold onto the cash, are beginning to advise you to start buying stock. But you were buying stock throughout the entire year, thus accumulating 26.25 more shares, not at the original $500.00 price but at the $400.00 price. Your portfolio now has an amassed amount of 31.5 shares. Crunching the numbers, your first four shares cost you $2,000.00 and your next 27.5 shares were a total of $11,000.00. That would give you a total of 31.5 shares at $13,000.00 for an average cost of $412.69 per share. So buying was a good thing – a VERY good thing.
But now as the market rebounds, the cost of the stock is going up. People are excited! This also means that the stock that you had been buying for $400.00 goes back up to the original $500.00 per share. Not the best news for buying but good news for the return. As you continued to purchase during the downturn, you had a 21% gain. Those who cashed in and did nothing had a zero % gain – ZERO.
This is just how the market works. The market has highs and lows. Long term investors realize they can’t time the market and jump at every dip or spike. They will continue to buy at the lower prices and add to their portfolios. They will wait it out with patience and fortitude. This is not the first time the market will dip and it won’t be the last. Just understand that the market will rebound, so it is usually best to stay in the game, buying low and reaping the benefits.
For more specific questions about your portfolio, buying and selling stock, or any budgetary needs, contact me. Also, follow me at Budgetdog and tune in to my Podcasts.