One story I hear again and again about investing in equities, is how easy it is to lose a lot of money. While this is true to a certain extent, there are ways to mitigate these risks.
In the late 1990’s many investors got caught up in highly speculative tech stocks, when high prices of many issues were unsupported by their profit levels – or in many cases unsupported by any profits at all. With the benefit of hindsight, it is obvious that this bubble had to eventually burst. Engaging in this kind of speculative investing in hopes of rapid short term gains is somewhat of a gamble, and a very easy way to squander a lot of capital.
Investing in the latest ‘sure thing’ may pay for a while, but eventually you are going to get burned. For those willing to settle for slower but surer returns, purchasing positions in solid companies with a long track record – and preferably a wide moat protecting their business – at a fair or discounted value is a lot more likely to provide satisfactory results.
Of course, even prudent investors can find the value of their holdings go down considerably at times. During the financial crisis the S&P 500 dropped from a high of over 1500+ in late 2008, down to less than 700+ in 2009. While some companies – especially those financial firms dependent on leverage and mortgage based securities – suffered dramatic falls in share price for good reason, other non-financial firms also fell drastically.
Stalwarts such as Coca Cola – little impacted by troubles in the financial sector – traded as much as 25% lower in the depths of the financial crisis bear market than it did beforehand. Did the intrinsic value of KO really decrease that much? I don’t think so. Earnings continued to grow, dividend were still paid out – and continued to increase annually.
During this time many 401(k) investors – seeing their balances decline by so much – sold all of the equity positions in their retirement accounts. Now that the markets have fully recovered and now exceeded their former 2008 highs, these people have missed the opportunity for huge gains and will suffer in retirement accordingly.
For investors who have purchased shares in a quality blue chip company – KO is only one example, others are JNJ, PG, NSRGY, MCD – at a reasonable price, a stock market crash is not a time to panic and sell. These firms are – barring catastrophe – not going away. They sell products that people will continue to buy in good times and bad.
If the economy is down for some reason – recession, war, famine – the market as a whole might punish these firms out of fear they will not perform as well in the near team. However, looking out into the future we can see from history these basic, somewhat boring firms, will continue to prosper and thrive when times improve. In fact, with proper management, the down times can provide a quality firm the change to take market share from less sound competitors.
Rather than panicking and selling when your investment in Johnson and Johnson drops 20% due to some temporary bad news, stop and consider what is happening. Is there some specific event that will truly impair the long term prospects of this particular company? If not, take advantage of those panic driven sellers pushing down the price and increase your holding.
Don’t let fear and panic mess with your mind in the next stock market crash. Hold the positions you have in quality companies and look for bargains to deploy any available cash you have. If you can pick up ‘best of the best’ firms at a P/E of 15 of less – particularly during temporary periods of depressed earnings – then you have excellent odds of great returns when the psychology of the markets turns bullish once more.