Should You Buy Stocks When They Are Down?

As the stock market goes down, it often becomes more challenging to continue to invest. After all, you want to buy a stock and watch it go up in value as opposed to going down in value. For new investors, it can be gut wrenching to watch their portfolio go down in value.

The natural response when the stock market goes down for inexperienced investors is to first panic, and then sell all of their stocks as a result of that panic. There is an underlying expectation that guides this panic. Many new investors believe, or perhaps want to believe that the stock market always goes up.

This is simply not true. Ever since the stock market was created, there have been ups and downs. When you invest in the stock market, it is important to set the expectation in your mind that sometimes the market will be up and sometimes the market will be down.

Additionally, when you take a step back and look at the bigger picture, the stock market has historically gone up over time. We can look at a snapshot of the S&P 500 stock market index to prove this. This index is often used to gauge how the stock market is doing as a whole.  

As you can see from the S&P 500 index, the stock market does tend to go up over time. However, it clearly does not go up every year. There are lots of years when the stock market stays stagnant, goes down, or crashes.

When you invest in a mix of high quality stocks, the most important action you can take is to keep investing even when the stock market is down. It is tempting to make decisions based upon the short term performance of the stock market, but you need to take a step back and look at the bigger picture.

For example, say that you were investing in the stock market to save for your retirement. You decide to hold stocks in a Roth IRA. You are currently 30 years old and plan to retire when you are 65 years old. You assume that you can get a return of 8% from the stock market.

You plan to invest $500 per month. Using the assumptions above, you would have just over $1 million when you retire. During these 35 years, it is inevitable that the stock market is going to be down at some point. It is vital to not panic and continue to invest during these times. If you stop investing, you can miss out on growth when the stock market recovers.

Imagine a hypothetical scenario in which you are a stock market wizard. You are able to predict with complete accuracy when the stock market will go up, and then when the stock market will go down. You are able to pinpoint the exact prices at which the ups and downs will happen.

If you were able to do this, you would be able to sell at the peaks and buy the dips to maximize profits. Sounds great right? Well, sorry to burst your bubble, but this is not reality. No one is able to time the market. Not even the best investors in the world.

This is why it is important to invest even when the stock market goes down. If you steadily invest over time, you are going to experience some downs, but it is also inevitable that you will experience some ups. Sitting on the sideline to try and time the best point to enter the stock market is a bad idea.

This does take discipline to do. You might be speaking with a family friend who is a self described "stock expert" that tells you to wait for the "perfect" time to start investing. He or she is wrong. The best time to enter the stock market is now regardless of what is happening and steadily invest.

Legendary investor Warren Buffet summed this concept up by saying, "I can't predict the short-term movements of the stock market. What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up. So if you wait for the robins, spring will be over."

A perspective shift can be useful when stocks go down. Instead of looking at the down turns of the stock market as troubling, you can instead look at the down turns of the stock market as an opportunity. Everything goes on sale.

Imagine that you wanted a new pair of shoes that cost $200. If the shoes went on sale for $150, would you be upset? Of course not. You would be happy to get a high quality pair of shoes at a discount. The same logic can be applied to the stock market.

When the stock market goes down, it is an opportunity to buy high quality companies at a discount and wait until the stock recovers. You do have to be careful when applying this logic. Just because the price of a stock goes down, does not mean that you should buy it.

The company that sells the stock may have lackluster performance which is what may be causing the stock to dip in value. However, if a company has strong performance and the stock goes down, the ability to buy that company's stock at a discount is valuable.  

When the stock market goes down in value, many investors' immediate response is to sell their investments to prevent further loss. The reason for this is that they believe they are losing money, but is this what is truly happening?

In the stock market, there are what is called realized losses and unrealized losses. An unrealized loss is only a loss on paper and a realized loss is a true loss. For example, say that you have been investing for a couple of months and have built up a small stock portfolio which is worth $1,000.

Say that the stock market goes down suddenly by 15%. Your stock portfolio would now be worth $850. However, you are smart and decide to continue to invest knowing the stock market will likely recover given enough time.

This is what is called an unrealized loss. Since you did not sell the stocks, the loss is only on paper. A realized loss happens when you sell the investments and lock in the loss. So, if your stock portfolio went down to $850 and you then sold all your stocks, you would lock in a realized loss of $150.

Understanding this can help provide relief when the stock market goes down. It may appear that you have lost money, but until you sell your investments at a loss you have not lost anything. This will help you to keep investing when the inevitable down turns of the stock market happen.

At this point, you now understand that the ups and downs of the stock market are normal, that you cannot time the market, that stocks are on sale when they go down, and that you don't lose money until you sell. When you understand all of these facts, you can start to accept that it is a good idea to keep buying stocks even when they go down in value.

The question is how do you do this? The easiest way to do this is to employ a dollar cost averaging strategy. Dollar cost averaging is a strategy in which you invest a fixed amount of money into the stock market per month regardless of the price of the stocks.

For example, say that you review your budget and have $250 that you can invest per month. Each month you are going to invest this $250 into the stock market regardless of what is happening. When the stock market is up, you invest $250 each month. When the stock market is down, you invest $250 each month.

When the stock market moves sideways, you invest $250 each month. This strategy does several things for you. First, it will help you to continue to invest when the stock market goes down. By continually investing at the same interval, you guarantee that you will not miss out on the opportunity to buy stocks at a discount and that you will not miss out on the growth of the stock market.

Secondly, it eliminates the temptation to try to time the market, which as noted previously is impossible. As opposed to attempting to figure out the perfect time to invest, you simply invest consistently. Doing this helps eliminate the emotions that can often be tied to investing.

Thirdly, dollar cost averaging allows individuals with small budgets to start investing. Most people do not have a few hundred thousand dollars to dump into the stock market. Dollar cost averaging allows you to consistently invest small amounts of money that will grow into large amounts over time thanks to compound interest.  

It is important to note that dollar cost averaging only works over long periods of time. If you only use dollar cost averaging for a short period of time, it will not work. For example, say that you can invest $100 per month into the stock market.

Say that you do this for a year straight. During this year, the stock market went down 10% as a whole. At the end of the year you might throw your hands in the air and claim that dollar cost averaging does not work. However, if you dollar cost average for 20 years, it is highly likely that your money will have grown.

Why is this? In the short term the stock market is more volatile than the long term. This simply means that prices go up and down more frequently. However, over long stretches of time, the stock market does tend to go up if you ride out the down turns.

Whether you already own stocks, or are looking to start investing, there are a couple of other items that you should check off before starting. Doing these two things will help you have a more rounded financial plan and will reduce the stress that may happen when you buy stocks.

An emergency fund is a cash reserve that you can access to pay for unexpected expenses. It is important to have an emergency fund before you invest as you do not want to pay for unexpected expenses from your investments.

For example, say that you had $1,000 in your bank account and wanted to start investing. You decide to put the entire $1,000 into the stock market. A few months go by and your car breaks down. You need to get it fixed and find out it is going to cost $900.

Since you no longer have any cash available, you will have to sell your stocks to fix your car. If the stock market happened to be down at this point, you would have to sell your investments at a loss. This is why it is important to have an emergency fund before you buy stocks.

The reality is that life will get in the way of your investing plans, so it is important to be prepared. Many financial experts recommend having at least 3 to 6 months worth of expenses in an emergency fund, but at the very least you should have $1,000.

A good place to build an emergency fund is through a high yield savings account. A high yield savings account is a bank account that pays a higher APY than a normal savings account. This will allow your cash to grow and maintain its value depending on the current levels of inflation.

Secondly, you need to pay off high interest debt before buying stocks. Credit card debt would fall in this category. Say that you have been irresponsible with a credit card and now have $2,000 worth of credit card debt at a 20% interest rate.

You would likely only be able to earn 10% in the stock market at best, so it makes more sense to eliminate this high interest debt before investing. Once you have eliminated high interest debt, you can start to send your dollars into the stock market.

Keep in mind that you do not have to pay off every last "debt" that you have before investing. For example, say you have a car loan at a 5% interest rate. Since your money can earn more than that in the stock market, you do not have to send extra payments to the car to get it paid off before you invest.

You can learn more about how to think through debt as you invest in our analysis of what true debt is.

We previously noted that just because a stock goes down in value, does not mean you should buy it. Your goal as an investor is to buy high quality stocks that you believe will perform well over the long haul. This does not mean that high quality stocks do not go up and down, but it does mean you can be confident in their performance over time.

The vast majority of investors do not have the skills to pick individual stocks to hold for the next 30 years. This does not mean you can't pick individual stocks to invest in, but a much better alternative for the average investor is to invest in investment funds.

An investment fund pools the resources of many different investors to buy lots of stocks all at once. When you buy a share of an investment fund, you get exposure to all of the stocks that the fund owns at the same time.

Mutual funds, index funds, and ETFs are all common investment funds. Instead of trying to pick your own stocks, you can simply invest your money into one of these. Investment funds are composed of high quality companies.

For example, an S&P 500 index fund holds the stocks of the 500 leading companies in the US. If you were to buy shares in an index fund, you would get exposure to all of these stocks from companies that you already know and use. Think of companies like Apple, Coca-Cola, Chipotle, Amazon and many more.

Like individual stocks, investment funds will go down in value. However, since these funds are composed of high quality companies, you can be confident that they will recover from the down turns. This gives you the confidence to keep investing even when the investment fund is down.  

The bottom line is that you should keep buying stocks even when the market is down. It is important to understand that the ups and downs of the stock market are normal. If you try to time the exact moment to buy or sell stocks, you are not going about things the right way.

Try to look at the downturns of the stock market as an opportunity to buy good companies at a discount, and understand that you don't lose money in the stock market until you sell your investments. You can use a dollar cost averaging strategy to stay consistent with your investing whether the market is up or down.

Before you buy stocks, it is important that you have an emergency fund and pay off high interest debt. An emergency fund will ensure you don't have to sell investments to cover unexpected expenses. If the stock market is down, you don't want to sell your investments and lock in that loss.  

Finally, your focus as an investor should be to own the stocks of high quality companies. When the stock market goes down, you will have the confidence to continue to invest if you own high quality companies that provide value to people.