Down markets can be good news for stock investors as well. “Buy low and sell high” is a well-known mantra but if it were easy to do, we’d all be rich. In the broad market, including mutual funds, in order for someone to make a lot of money, someone else has to lose a lot of money. Individual non-professional investors usually do just the opposite of buy low, sell high. So Mom and Pop investors are actually supporting the profits of the pros. How does investing in a down market help you compete with the pros?
There is a group of investors who call themselves “contrarians.” Their philosophy is very simple. Most people will invest in a fund when it is on the rise. In fact, they are most likely to invest in a fund that has gotten a lot of publicity for how well it is doing. That is precisely the wrong time to invest in a fund or a stock. By the time everyone agrees that a certain fund is really hot, that fund is getting near its high and it is exactly the worst time to buy. When the unwashed crowds are buying, the smart money is selling.
The same is true at the other end. As a fund begins to drop, the inexperienced fund investor dumps the fund, the same fund that they paid too much for when it was hot, thereby losing money. The contrarian looks at this suffering fund that no one loves any more and they say, “This fund is close to the bottom. Now is the time to buy.”
It should be said that just because the market is down doesn’t mean that it’s going to turn around, but stocks and funds are cyclical. Unless the stocks that make up a fund are really in bad shape, a dip in the market and a drop in the fund price (Net Assent Value, NAV) can be a great opportunity to buy.
When a fund is hot and everybody loves it, sell. When it is cold and is shunned by the masses, buy. If a fund has sound fundamentals and well-valued stocks and is down because the broad market is down, that is a good time to buy. The stock market is more of an emotional animal than a rational one. The perception of a fund or stock may be more important than the actual value. If you want to be successful investing in funds, put your emotions away and be as cold as you can. Whatever you do, don’t follow the masses. They are almost always wrong.
Just prior to the great stock market crash and depression, the markets were feeling quite exuberant and positive, just like we seem to be feeling right now. Very few anticipated the crash that was imminent.