Now, as I’ve mentioned a few times before, by no means am I an expert on investing (yet..), but there are a few concepts that I have picked up along the way and that I’d like to share at this stage. These are to do with the practicalities when it comes to investing on a day-to-day (or year-to-year) basis.
As I have said before, I – and with me many others on their way to financial independence -, see index investing as the safest, easiest and surest way to invest. It is boring, but most likely to get decent results. Of course not everybody agrees, there are many who prefer other ways to invest, (or of course to not invest at all), so make sure you choose what is good for you. With that said, I am mainly referring to index investing in this step, so not everything might be applicable to the other ways of investing.
Bull & Bear Markets
Let’s first start with two definitions in the investing world: bull and bear markets. During a bull market, the general market does well: prices are on the rise, investors feel confident, every day more people want to buy shares which pushes the prices further up as demand exceeds supply, people see their portfolio grow and demand increases even further..
The opposite of a bull market is a bear market. Prices drop, sometimes very quickly, investors lose confidence, see their portfolio drop in value and desperately try to sell their shares – often below the original purchase price -, there is more supply than demand making share prices decrease even more… If you buy just before the start of a bull market, you probably end up losing a lot of the money you invested very quickly, as you would have bought shares when they were very expensive and suddenly see them going down ever further uncontrollably.
I guess it’s easy to see which one of these markets is the one you should be hoping for, right?
Well, let’s have a look at the following key investing principles and truths before we actually answer that question.
- Shares and bonds have no actual value until you sell. On paper you might have $50.000 in shares at the moment, but that money isn’t yours unless you liquidate, and whatever their value is today might be completely different the moment you actually sell.
- Taking the above point into consideration, you don’t actually make a loss until you sell. If you invest $10.000 today and see your shares drop down to $5.000 tomorrow, if you don’t sell, you won’t have lost anything.
- The same of course is true with any increases in the value of your assets: if you original $10.000 investment is worth $20.000 tomorrow, the value might go right down to $10.000 the very next day, with the $20.000 you had in between accounting for nothing.
- When prices drop people sell hoping to at least cash in what can still be cashed in before it is too late, worried shares won’t ever recover anymore or that a company ceases to exist altogether, meaning those shares will be worth a whopping $0 and won’t ever increase anymore. Ever.
- Until you sell, you don’t pay income taxes on your assets (although you might be charged taxes on your assets depending on where you live, but this is usually lower than income tax).
- Once you sell, you pay taxes. If you invested $10.000 then sell a month later at $5.000, you won’t only have lost $5.000, but you’ll also need to pay taxes on the $5.000 that you received when you sold your shares.
That very quickly in terms of some basic investing principles. Now let’s take this all to the next level and consider the following.
- What if during a bear market, instead of joining the crowds and putting your shares on offer, you held on to your investments? If you have the time and the patience, here’s a secret: prices will go up again. It might take 6 months, a year, 3 years or far longer. But instead of counting your losses now, just hold on to your shares and wait. You haven’t lost any money until you sell. If you don’t sell for another 10 years when the shares are back up and even far above their highest price of recently, you’ll win instead of lose.
- The biggest problem with the above strategy? Your emotions: fear resulting in panic. Fear that prices will drop even further, fear that the market won’t ever recover anymore, fear that you’re the only one (or so you think!) holding on, whilst everybody else is at least liquidating what they can still get. Yet history has shown that the prices will go up again. As long as you can overcome your fear, you can also overcome the financial loss. Sit still and wait, stop looking at your investments on a daily basis and just wait for better times.
- Remember that even when stock prices fall, you’re most likely still earning dividends on your shares.
- Now consider taking all of this another step further: Use a bear market to your advantage: buy! Shares at this stage are super cheap, see it as one giant sale that you can use to your benefit. Buy now when your money can get you more shares than ever.
Initially it maybe sounded great to invest during a bull market, but is it really upon closer inspection? Bull markets drive the prices up, which is great if you want to sell now (or just for your own peace of mind), but from a long-term point of view if you have no intention of selling now, starting with a bear market is actually a great way to buy lots of shares at low prices.
Step 54 – Bull & Bear Markets – in detail:
- What would you do if share prices start to fall? Do you think you could resist the temptation to sell?
- What if your friends, colleagues, family or financial adviser all urge you to sell, telling you you’ll lose all of it if you don’t sell right now, this minute preferably. Could you resist the pressure?
- Would you be able to take advantage of the situation and actually increase your investments when shares are on offer due to low prices? Or would you be too afraid?
- We all like to think that we are better, more intelligent, stronger than the next person, but are we really? Or will you and me when the push comes to the shove do exactly the same as everybody else and panic, sell and see our money and years’ long patience evaporate because we were too scared?
- Grab your file and write down a “contract” with yourself that if you own shares at some point in the future and see prices drop, that you’ll do the exact opposite of what the majority of people do: you hold on to what you’ve got and you might if possible indeed put in extra money to buy some more shares in the sale. Use the above questions to phrase your own “code of conduct” for when the next bear market comes around.
Investing is all to do with emotions. Or better said: controlling emotions. Those that can resist fear, panic and social pressure and instead use their logic to “sell when everybody in buying, and buy when everybody is selling” will fare much better in the long-term. But that is often easier said than done… Stay strong!
Read more about my 100 steps mission to financial independence or simply decide to take control today and join us on our step-by-step quest on how to make your finances work for you, starting with step 1.