With all the volatility in the stock market, new investors often worry about investing when stock prices are high, only to watch the value go down. No one wants to overpay, least of all for their retirement account.
Some people call it timing the market, or “buy low, sell high.” The most important question is whether the underlying fundamentals are quality or not. The meteoric rise of tech stocks and bitcoin a few years ago contributed greatly to this sentiment among working professionals, many of whom are millennials and younger – no one wants to miss out on the way up, but we’re all nervous about losing money.
My long-term investment strategy, as suggested by Warren Buffett and many others, is to invest in the whole stock market through an index fund over the course of my career to slowly build my wealth. So, when a friend asked whether they should invest in Tesla and Amazon because they seem underpriced, here’s how I responded. 1 TL;DR answer: Diversity your risk and invest over time.
The difference between Warren Buffett and us, other than the obvious, is that he has the necessary experience and the ability to perform extensive analysis on a single company. 2 He can afford to try and time the market, but for the average investor it’s entirely impractical. Warren Buffett buys entire companies; we can’t afford that kind of specific risk.
In other words, we should avoid committing large portions of our net worth betting on the performance of individual companies.
Instead of going “all in” on one or a few companies, wouldn’t it make more sense to diversify risk over a whole portfolio of companies? Financial services firms have created investment products to meet the desire of investors to diversify with index funds that do all the diversification for me. Some index funds even purchase a bit of every company in the entire stock market, lowering the risk of any individual stock dropping. Instead of putting all of your eggs in one basket, it makes sense to diversify and reduce risk. The easiest and least expensive way is with index funds. 3
Dollar Cost Averaging
One way to think about stock prices is if the price of a stock drops, it’s on sale. If you believe that company will ultimately be successful, should you invest more when prices drop? Maybe, but it takes a lot of willpower to do so. Also, if prices drop even further you’ll wish you had waited longer to invest your money. But, if the stock price starts to rise again and you’ve been waiting to invest you’ll wish you bought sooner. This is where dollar cost averaging comes in.
Time in the market is more important than timing the market.
Instead of making large, lump investments, it makes more sense for most to invest a set amount each month as part of my budget, investing through a 401K or private investment account. I can average out the cost of those investments over a very long time horizon, and ride out the lows and highs of the market. Simply put, “set it and forget it.” It may seem like I’m overpaying sometimes, but it will feel like I am getting a bargain other times.
Am I going to invest more since the underlying assets seem cheaper? No.
The stock market has taken a significant downturn, but that shouldn’t change the average investor’s plan, particularly someone that is starting out (Under 50. Yes, 50). Don’t let seemingly low prices entice you into investing more than you can or should based on your risk appetite and budget.
Personally, I am just going to stay the course. I hope that everyone who can does the same.
Sam is not an investment professional. This article is meant to encourage people to do their own research and should not to be taken as financial/investing advice.
Written by Sam Freiberg. Sam is a graduate of Cleveland State University (Go Vikes!) and passed the CPA exam. He works for large public accounting firm and lives in Cleveland, Ohio. Connect with Sam directly at Samuelhfreiberg@gmail.com.