In August of 2015, the stock market dropped to its lowest point in 3 years. Earlier in 2015, in January/February, the stock market took another sharp downward turn. These weren’t technically “crashes”. Crashes happened in 2000 and 2008, where the S&P 500 saw double-digit losses within days. More recently we’ve experienced what is commonly known as a “dip”, a “correction”, or a relatively quick decline of about 2-5%. We got another one more recently, on the news of Brexit. I opened my investment accounts and my day gain/loss view was filled with red ink.

I was giddy.

What is she smoking? you’re thinking. Isn’t the point of buying stocks to see them rise in value? You aren’t wrong. It is for some people, for some stocks, for some strategies, and appropriate for those in the distribution phase of their investment life.

For me, I’m in the accumulation phase of my wealth-building journey. I’m over here slowly but surely collecting cash-generating assets at the fairest price possible, which can be difficult when you employ the Bottom Up investing approach that we do. You never want to try to time the market, but paying too much for even the most profitable companies can cause a serious drag on your returns.

Low share prices can be good news if you’re:

  1. Young and accumulating assets
  2. Investing for income (don’t touch the principal)
  3. Reinvesting dividends
  4. Dollar-cost averaging
  5. Buying at all, actually.

Panic selling only because share prices drop mystifies me. The only time high prices are beneficial to a long-term investor is when they’re selling. If you’re a buy and hold investor who spends time doing your due diligence on and collecting high-quality companies, it’s likely selling will be infrequent. When everyone else is selling, that could mean it’s time to stock up.

This isn’t to say we completely ignore a price drop. We ask questions and find answers. We research and reassess the company’s performance, financials, and pipelines. If nothing concerning the structure of the actual company has changed, it could present a buying opportunity.

Here’s what happens when you’re investing $1000 a year in a high-quality company whose fundamentals remain strong over 13 years. In the first column, we’re purchasing our shares at a steadily rising share price (this is for illustrative purposes only. The stock market doesn’t operate this neatly, generally speaking, and does not include any investment fees or taxes). In the second column, we have a share price that crashed 20% early on and then rebounds in linear fashion (also for illustrative purposes only. You should not interpret the hypothetical charts of this hypothetical business as a guarantee for your individual returns). The dollar amount invested once per year remains constant, as does the ending value of the shares in each scenario.

$1000/year Investment

Steady Growth

Early Crash

Starting Price/Number Of Shares

$50 / 20

$50 / 20

Year 2 Purchase Price/# Of Shares

$54 / 19

$55 / 18

Year 3 Purchase Price/# Of Shares

$59 /17

$45 / 22

Year 4 Purchase Price/# Of Shares

$64 /16

$40 / 25

Year 5 Purchase Price/# Of Shares

$68 / 15

$47 / 21

Year 6 Purchase Price/# Of Shares

$72 / 14

$55 / 18

Year 7 Purchase Price/# Of Shares

$76 / 13

$60 / 17

Year 8 Purchase Price/# Of Shares

$81 / 12

$67 / 15

Year 9 Purchase Price/# Of Shares

$86 / 12

$75 / 13

Year 10 Purchase Price/# Of Shares

$91 / 11

$83 / 12

Year 11 Purchase Price/# Of Shares

$94 /10

$90 / 11

Year 12 Purchase Price/# Of Shares

$98 /10

$95 / 11

Ending Price/ No Purchase

$100

$100

*share counts are rounded to the nearest whole share.

Results

Total Number of Shares

169

203

Total Principal Invested

$12,000

$12,000

Total Account Balance At Year 13

$16,685

$20,347

Total Capital Gains

$4865

$8347

Average Price Paid Per Share

$71.15

$58.98

Total Return On Investment

40.55%

69.57%

Let’s read from the top and look at year 3. What if when the share price dropped, instead of confirming the strong fundamentals of the business you felt confident enough to purchase initially, you panicked and sold your shares at $45 each? Not only would you have lost $740 outright from what you originally paid, (ouch), but you’d also have an opportunity cost of $8347 by abandoning your investment plan and missing out on both the recovery and subsequent growth of the share price.

However, being the informed investor you are, you stayed the course. You saw that the company was still doing well and weren’t distracted by a random man in the news foolishly choking on nectarine pit (if you don’t understand that reference, check out our Tale For Beginning Investors). When the stock market reacted irrationally, you bought your shares at a great discount. Your $1000, in year 4, bought you 5 more shares than it did when you first made your investment. Not only did you still make money, but you got a better return on your investment than if your shares had steadily increased in value. If this fictional company paid you dividends along the way and you opted to reinvest them, you did even better. To put the cherry on top of your money sundae, once you get your groove and are able to more accurately determine whether a price is high, just fair, or exceptionally low, you can buy more heavily when it’s low and increase your overall return even more. Read more about developing a smart investing strategy in How To Become A Killer Investor.

Perhaps you’ve heard what might be the oldest, most basic, tried-and-true investing strategy: “Buy low, sell high”. When it comes to businesses of superior quality and profitability, opportunities to buy low can be infrequent. Don’t freak out when the stock market dips. Celebrate!

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