Buying During Bad News
Disclaimer: Please note that all content and information in this blog are for educational and informational purposes only and should not be taken as professional investment advice.
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1. You believe the market has overreacted
2. You believe the market will recover
One focuses on the present, one on the future.
Both are equally difficult to assess with reasonable certainty.
You will never know whether the market has truly overreacted to the bad news, or even underreacted.
Likewise, you will never know whether the market will recover.
Even though there are no guarantees, we can make our decision based on what has happened before — history.
Historically, markets tend to overreact to bad news. Investors tend to over-penalise bad news because investors are risk-averse.
A minor bad news is able to cause a major market sell-off.
Markets have historically shown resilience. Not just the US market, but most markets globally. Recovery is almost a guarantee — the question is how long it will take.
If recovery takes too long, you'll probably be better off investing in other assets apart from equities.
But normally recovery is quick.
And how quick a recovery largely depends on how deep of a discount you bought at.
The deeper the discount, the quicker the recovery.
If you bought at all-time highs, and the market collapses, it will take a much longer time to recover your losses back to breakeven.
Whereas if you bought at the market bottom, your recovery is almost immediate.
Therefore the timing of your investment — which determines the price you pay and hence the discount you get, has a strong influence on the speed of recovery.
Another important factor about recovery is the extent of it. There's no point seeing a quick recovery only for your recovery to only cover your losses but not give you any profits.
A recovery is no recovery if it doesn't give you profits. It is one thing to breakeven but another to make profits.
We invest to profit, not breakeven, therefore we expect our recovery to give us reasonable returns, not just recover our losses.
This is why it's important to continue buying even as the market trends lower because you never know the bottom so the best you can do is to consistently buy.
This naturally lowers down your average cost — making it closer to the bottom, which is beneficial as you're much more likely to make profits when the market recovers if you bought near the lows.
The timing of your investment is therefore as important as what you invest in. If your timing is totally off, you can take a long time to recover from market downturns.
As such, it pays to not only invest consistently but to invest skilfully. Knowing when to invest and how much to invest each time is crucial in determining the level of discount and hence returns you get.
We want as much discount on the quality assets we invest in, and the only time such assets are discounted is during times of great economic uncertainty and fears. The greater the fear and uncertainty, the greater the discount you get.
A discount can be seen as the market paying you a premium for taking on greater risk and uncertainty. When you invest during such times, the market has no choice but to reward you with a greater premium by offering the same assets at a steep discount.
When you view market downturns not as times of fear and panic but as times to accumulate the same assets at a discount, you'll not feel fearful but you'll feel excited and possibly greedy.
As Buffett says, be fearful when others are greedy and greedy when others are fearful. That together with the skill to decide much to buy each time the market trends lower will yield you above-average returns in the long-term.
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Disclaimer:
The content and information provided on this blog is solely for educational and informational purposes, and should not be construed as financial advice. The accuracy or completeness of the content and information provided in the blog cannot be guaranteed. Before making any investment decisions, it is important for readers to research and carry out independent verification of the information provided, or consult with a qualified financial professional. No warranty and no liability whatsoever is accepted for any loss arising whether directly or indirectly as a result of actions taken based on the ideas or information found in this blog.
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