How do you make money when stock goes down? Counter-intuitively, it’s easier. When the stock market takes a downturn, like it did in 2008, or in late 2018/early 2019, it’s actually an opportunity. Let’s talk about what to do when the stock market falls.
Generally speaking, there are three ways to make money on stocks. The first way is on appreciation, or the increase in value of the stock itself. The second way is through dividends. The stock market going down makes it easier to make money on both of these things. Your money buys more stock, which gives you more shares to recover value. And the more shares you own, the more dividends you receive. And the third is through your employer match, if you receive one.
What to do when the stock market falls
It was early March 2009. Things were looking bad. The stock market had lost more than half its value since its peak in October 2007. When I got in to work, some of my coworkers were on the phone, frantically trying to cash out their investments. Another coworker called HR. “I want to know how to stop contributing to my 401(K) since it’s not increasing in value,” he said.
“You’re making a mistake,” I interjected when he got off the phone. He blew me off and went outside to smoke. But a couple of my other coworkers perked up and asked me what I meant.
“What would you do if gas dropped to 50 cents a gallon?” I asked.
“I’d buy all I could,” they said.
“Right. Because you know it’s not going to stay at 50 cents a gallon. Stocks are going to do the same thing.”
I actually talked those two coworkers into increasing their 401(K) contributions. And then I went and did exactly the same thing. From early 2009 to mid 2012 when I changed jobs again and lost 401(K) eligibility temporarily, I bought as much stock as I could. In 2018, even with the downturn, that stock I bought on that dark day in 2009 is worth four times what I paid for it.
How do you make money in the stock market?
We feel good when the market is setting record highs several times a year, because it feels like we’re making money. But it’s more of an illusion than reality. Our portfolios are increasing, but we’re buying at these high prices too. And once that run of record highs slows down, we actually lose quite a bit of the modest appreciation.
In the long run, we actually make our money in three different ways.
When I changed jobs in 2015, I opened a brand-new 401(K) with that employer. The market was on a tear that continued until after I left that job in 2017. I made money off my employer match, so that was reason to keep contributing. Employer match varies but if you have to contribute 8 percent of your salary to get a 4 percent match, that means if you invest $4,000 to get a $2,000 match, that’s a 50 percent return on investment. Nice.
I didn’t track what I made off the dividends but it was likely another 2-4 percent. So the returns were nothing to sneeze at, but I was getting that in 2009 and my share prices appreciated like gangbusters during the recovery.
So even when the market is down, you make money two of three ways during a lean year. You get your employer match, which is an automatic profit. You get dividends. Not all companies pay dividends, but the mutual funds a 401(K) plan offers are likely to be heavy in dividend-paying companies, because those tend to be safer investments.
And then, when the market recovers, you make your real money. At that point, all of the stock you bought at a deep discount during the down market gives you double-digit returns, on top of any dividends and employer match you may have coming to you.
Counter-intuitively, the best way to make money in a bull market is to buy stock during the bear market that precedes it. So yes, you can make money off a bear market.
The dangers of market timing
It’s tempting to try to time the market, to buy when shares are low so you can maximize your profits later. The problem with this is you never know when the market is at rock bottom until after it happened and it’s too late to capitalize on it. Sometimes the market sputters, like it did in late 2018, alternating between one or two days of triple-digit losses followed by a day or two of triple-digit recovery. Often those recoveries are caused by other people trying to time the market too.
You’re much better off just withholding a set amount from your paycheck every pay period. Some weeks you’ll buy high and some weeks you’ll buy low this way, but most importantly, it keeps you in the game. Perhaps the biggest danger of trying to time the market is waiting too long, investing nothing in the meantime, and then missing the opportunity altogether. Investing automatically won’t get you the optimal timing all the time. But the thing to remember is that during every 10-year period in the history of the stock market, an investor who bought and held made money. Even during the Great Depression. An investor who bought at the peak of the market in 1929, held it through the crash, and still had the stock in 1939 made money anyway, in spite of the worst possible timing in history up to that point.
What to invest in
The other danger in investing is being too cautious and missing out on opportunities, or being too aggressive and losing money in busts. For example, I lost most of my savings in the 2001 dot-com bust. I knew better than to be investing in things like AOL, because I knew its shelf life was limited and it wasn’t going to be able to compete with cable modems and DSL once the masses discovered those then-new technologies. I also knew most of those startups at the time were going to be in a world of hurt once traditional retailers built an online presence. But I let a hotshot financial adviser convince me otherwise. I lost a buttload of money and he lost his license to practice in Missouri.
Worse yet, I let him convince me to cash out and stash the money somewhere safer. Not every stock I owned went bust. If we’d ridden out AOL, we would have recovered some value. If we’d ridden out Cisco, we would have recovered a lot of value.
Your 401(K) options are limited. That’s good.
Fortunately, your 401(K) doesn’t let you do what I did. It probably offers a choice of five or six mutual funds, falling into broad categories of things like big domestic companies, small domestic companies, bonds, large overseas companies, and a growth fund. You want to invest some amount in bonds, based on your age. One popular formula is to subtract your age from 100, or even 110 or 120, and allocate that to stocks. Then allocate the rest to bonds.
Confusing? Let’s say you’re 30. Subtract 30 from 120 to get 90. That means you should invest 90% in stock and 10% in bonds. If you’re 45, subtract that from 120 to get 75. That means a 45-year-old should invest 75% in stock and 25% in bonds.
Allocate the rest between the stock funds available to you. Here’s how I allocate mine, based on time-tested advice. The idea is that some years, one category will do better than the others and one will do worse. If your 401(K) account rebalances to keep your percentages constant, that forces it to sell the stuff that’s doing well to buy the stuff that’s doing worse, setting you up for gains next year.
If all of this is too hard, look and see if your 401(K) offers target date funds. These funds automatically adjust as you age, based on an anticipated retirement year. A Target 2025 fund will be fairly conservative, since someone retiring in 2025 needs the money pretty soon. A Target 2055 fund will be aggressive, since there’s lots of time to recover from hiccups in the market and it’s more profitable in the long run to take some risks to find the next Google.
How do you profit from the stock market?
The ways to profit from the stock market are from appreciation of share price, dividends, and employer match if you have one. Dividends may drop during a bear market but they don’t stop entirely, so dividends provide a source of income in both bull and bear markets. Some companies do better in bear markets and may actually increase their dividends. Of course, the employer match works no matter what the market is doing, virtually guaranteeing a healthy profit margin.
Can you make money in a bear market?
When your employer is matching your 401(K) contributions at 50 cents on the dollar up to a set percentage of your salary, that’s an automatic substantial profit margin in any market. But the real money comes in the recovery. Think of a bear market as a period of time, likely two years or less, when stock is on sale.
If I had contributed the then-legal maximum of $16,500 to my 401(K) and $5,000 to a Roth IRA in 2009, those investments would have been worth around $86,000 in 2018, even without dividends or an employer match.
This is why financial planners tell you to contribute whatever you have to contribute to your 401(K) to maximize your employer match, plus the legal maximum to a Roth IRA. Someone who does that religiously for several decades will have more than enough for a comfortable retirement.