It can be nerve-wracking to watch your portfolio consistently drop during bear market periods. After all, nobody likes losing money; that goes against the whole purpose of investing. However, pulling your money out of the stock market during down periods can often do more harm than good in the long term. Here’s why you should keep investing during such periods.
Use down periods to lower your cost basis
Although nobody likes seeing their investments decline in price, it can actually be a good opportunity for long-term investors because it’s a chance to lower your cost basis. Your cost basis essentially tells you the average price you paid per share for a particular company. If you bought 10 shares of a company at $100 each, your cost basis would be $100. If the stock’s price dropped to $80 and you purchased 10 more shares, your new cost basis would be $90 ($1,800 spent / 20 shares owned).
Lowering your cost basis is valuable because it increases your profit whenever you eventually sell your shares. Imagine you own 20 shares with a $90 cost basis, and someone else also owns 20 shares of the same company but with a $100 cost basis. If that stock’s price increases to $150 and you both sell, you would have profited $1,200, and they would have profited $1,000.
Although you both own the same number of shares, your profits are higher because you were able to lower your cost basis.
If you’re investing in sound businesses, don’t panic over short-term drops in price; consider it a blessing in disguise and put yourself in a better long-term position.
Time in the market is important
“Time in the market is better than timing the market” is an investing saying that has stood the test of time — and it’s one investors should always keep in mind. On one end, it points to how timing the market is virtually impossible to do consistently long term. It also speaks to the power of time in the market — especially regarding dividends.
Companies pay out dividends to reward their shareholders for holding on to their investments. If you’re investing in dividend-paying companies (preferably Dividend Aristocrats or Dividend Kingswhich also have stood the test of time), you’re doing yourself a disservice if you pull your money out due to drops in the market.
If you have $10,000 invested in a company or fund with a 3% annual dividend yield, you can expect to receive $300 in dividends each year. If the stock’s price is rising, you can expect that dividend payout; if the stock’s price is dropping, you can expect that dividend payout. The company’s stock price shouldn’t be your only focus as long as it manages to keep paying out dividends.
If you panic sell because the stock is dropping, you essentially remove an income source that could prove to be key to your return on investment. If the stock price drops and the value of your investment loses $200 in a year, but you made $300 from dividends, you still came out positive.
Don’t be an emotional investor
As an investor, it’s easy to get too high on the highs and too low on the lows in the short term. One of the best ways to remove some emotions from investing is applying dollar-cost averaging. Dollar-cost averaging involves making consistent investments at regular intervals, no matter what the stock price is at the time. It’s how 401(k) plans operate; no matter the cost of the investments, you contribute your designated amount each pay period.
Focusing on the end goal and ignoring the short-term volatility can make investing less stressful and can help prevent you from making emotional decisions that may go against your best long-term interest. Keep your eyes on the prize.