What To Do When The Stock Market Falls

The stock market is down over 8% so far in 2016.

Source: Google Finance

Price declines have sparked widespread fear in financial markets that 2016 will be ‘the year of the bear’.

There are a myriad of reasons why the market has fallen in 2016:

If you focus on negative short-term events the market looks bleak. The picture looks very different if you step back.

Source: Mutlpl.com

Notice the scale on the left-hand side of the image above is not linear. The stock market has exhibited exponential growth over long time periods.

“In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497.”
– Warren Buffett

To take advantage of exponential growth you cannot sell when the market dips down.

There are steps to take when the market falls. This article examines what to do when the stock market falls. It also gives 3 examples of high quality dividend growth stocks that are currently trading at a discount to fair value.

What To Do When The Stock Market Falls

There is a fantastic story that beautifully sums up what to do when the market falls.

“A broker who kept a brick on his desk would tell his new clients, ‘one of these days the market will go down and you’ll be upset – maybe so upset you’ll want to throw this brick through my window. Before you decide to throw this brick through my window I want you to do one thing I want you to write a check to your mutual fund company and tie it to this brick, because when the market falls, you should be thinking about buying more shares.’”

Source: Storyselling for Financial Advisors, page 225

The story above is very clear. You should be buying, not selling, when market fall.

As a side note, replace ‘mutual fund’ with ‘high quality dividend growth stock’ in the story above. Mutual funds tend to have high fees which hurt individual investor returns over time.

Warren Buffett On What Do To During Market Declines

Warren Buffett has 3 cornerstones of sound investing. All 3 are concepts Buffett finds to be critical to investment returns.

His second cornerstone is to look at market fluctuations as your friend rather than your enemy. Click here to see Buffett’s other 2 cornerstones of sound investing.

When markets are falling people tend to panic.

Most investors (including many professionals) see market fluctuations as their enemy. It’s easy to understand why. The quoted value of your investments has gone down. You have lost money (at least on paper).

Two facts take all the sting out of market falls:

Since you don’t have to sell when market prices fall, why would you?

If someone offered to buy your car one day for $20,000 and you didn’t sell then why would you sell if they came back a month later and offered you $10,000?

When the stock market falls we treat our assets differently. We want to sell our shares in great businesses because people will pay us less. That doesn’t make any sense.

As a seller you want a higher price. When prices get low, just don’t sell – even if other people are.

On the flip side, being a buyer is great during market falls. You get the opportunity to buy high quality businesses at a discount.

Think of market falls as coupons for 10%, 20%, 50%, or even more on ownership in great businesses.

“Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down”
– Warren Buffett

Market falls give you the opportunity to buy ‘high quality merchandise’ (high quality dividend growth stocks) at reduced prices. What could be better for compounding your long term wealth than that?

You have the opportunity to benefit from market fluctuations by purchasing great businesses when they go on sale, and only selling them when they become very overvalued.

“Be fearful when others are greedy and greedy only when others are fearful.”
– Warren Buffett

The 8 Rules of Dividend Investing are designed to help investors take advantage of market fluctuations and build a portfolio of high quality dividend growth stocks.

Warren Buffett does not just talk about holding through recessions. He actually does it. This is best exemplified by Buffett’s investment in American Express (AXP).

Buffett first invested in American Express in 1964. He has held the stock for over 50 years. A lot has happened in those 50 years. The market has seen exponential growth – and severe corrections. Buffett held through all of it.