Everyone loves a good sale—except when the sale is in the stock market.
With stocks in a downtrend since early January, people are rightly concerned about making good decisions with their money. In fact, the number one question I get in markets like this one: “Is now still a good time to invest more money?”
For investors that are actively accumulating shares of stocks—in a 401(k), brokerage account, or other investment account—I want to explain why this is exactly the type of market you should be hoping for. It’s in markets like this one where you get the chance to buy stocks on sale.
Stocks are ownership in companies
The concept of stock investing can be nebulous at times. Not only are your stocks intangible, represented by numbers on a paper or a computer screen, but the value of your stock changes daily. At times (sometimes for months on end) you will see the value of your stock plummet. It’s because of times like this that you question whether you are doing the right thing with your money.
I find it helpful to remind yourself of what stocks really are. Stocks represent shares of ownership in publicly traded companies like Exxon Mobil, Apple, JPMorgan, and The Home Depot. If you own stock, you are a part owner of a company like one of these.
A perk of being an owner is sharing in the growth and earnings of the company. Often, the company gives you a portion of their earnings, called a dividend, for simply being an owner of their stock. The rest of their earnings are retained and put to work in ways that will hopefully increase their future earnings and dividends.
Instead of thinking about stock as intangible assets on a statement, remember that they represent ownership of real businesses.
How to buy stocks on sale: an example
Stocks—just like any other asset—have prices that change regularly. If more people are buying stocks, the prices go up. If more people are selling, the prices go down. This not only affects the value of the stock you already purchased, it also affects the price you pay for new money you invest.
Pretend you are investing $500 every month into a stock fund—namely, the WisdomTree US Quality Dividend Growth ETF. This is a fund, meaning it’s a diversified collection of stocks (around 300 stocks in this particular fund).
You are investing in this fund because you have faith in the ability of US companies to continue their history of innovation, growth, and rewarding stock owners like yourself. When you started this investment in January 2022, the price of this fund was around $66 per share. At this price, you were able to buy 7.57 shares of the fund ($500 / $66 = 7.57 shares).
As the year progressed, the prices of stocks went down. It was disheartening to see your new portfolio drop in value. When you made your March transfer, your portfolio was down about 10%. The price per share of the fund was now $60, so your $500 investment was able to purchase 8.3 shares ($500 / $60 = 8.3 shares).
Determined to stick with it, you continued making monthly investments, even as the portfolio value bounced around. You were able to buy in April close to your original price as the market rebounded. But May and June saw back-to-back drops, and your June purchase price was around $55/share—a 16% drop from the start of the year.
But you noticed that you were able to purchase just over nine shares in June ($500 / $55.43 = 9.02 shares). Even though the value of your portfolio hit a new low in June, you were able to buy more shares of the fund with the same monthly investment.
This is it—this is how you buy stocks on sale! You continue to invest and purchase shares when stock prices are down.
Lower prices mean you are saving money. More precisely, you are buying more with the same amount of dollars. You started out buying 7.5 shares in January but purchased over eight and nine shares later in the year—all with the same monthly investment. Why? Because the price of the stock fund went down in price.
The goal of a regular investment plan
I stated that everyone loves a good sale except in the stock market. That’s because falling stock prices means the value of the nest egg you already accumulated also decreases. Because your hard-earned portfolio is going down, it’s hard to get excited for discounted stock prices.
If you are a long-term investor planning to invest at regular intervals, would you rather be purchasing at higher prices or lower prices?
If you are still going to be a buyer of stock for several years, the goal is to accumulate more shares. As you can see, you will accumulate more shares when you buy at lower prices. Yes, it’s not fun to see your account value drop by 16%. But again, you are a buyer. Isn’t this the type of market you should be hoping for?
When you are investing a fixed dollar amount, you are doing so without regard to the share price. This concept, called dollar cost averaging, means you will buy less shares when prices are higher and more shares when prices are lower. It’s a built-in mechanism to make disciplined investing decisions and collect the discounts that inevitably come along the way.
What if you are not actively buying stocks?
Not everyone is dollar cost averaging into the market. Do they still get to take advantage when prices are on sale?
Remember when I said companies pay you a portion of their earnings since you are an owner of their stock? Most people take these cash dividends and reinvest them into their portfolio. The dividend is then used to purchase more shares of stock.
This can be done automatically and is a common way to accumulate more shares. Even though you aren’t transferring additional money into your portfolio, your portfolio is generating income and is using that income to purchase even more shares.
Though the amount of dividends can seem small, they have an oversized effect on your total return over time because your dividends are automatically accumulating more shares.
The effects of dividend reinvestment can be seen in the graph below. The blue line represents the growth of a $10,000 investment in the WisdomTree US Quality Dividend Growth ETF made in 2013, minus the benefit of dividends. Over this nine-year period, the price of the fund had a few drops over 10%, two drops over 17%, and one drop of 32%. But you still managed to turn $10k into $23k.
This fund also paid cash dividends 114 times. Your total return—including the benefits of dividend reinvestment—was much higher than if you excluded dividends. As illustrated by the black line, your $10,000 investment turned into $29,300. Dividends had a lot to do with this.
While those dividends were purchasing additional shares every month, the greatest effect was made during the down markets—late 2018, the COVID crash, and 2022. Stocks were on sale and your dividends were busy buying up shares when everyone else was busy freaking out.
So yes—even if you are no longer investing regularly, you can still buy stocks on sale when you reinvest your dividends.
Bear markets are when you make the most money
About every five to six years the stock market will have a 20% off sale, called a bear market. Sometimes the discounts are deeper. These bear markets are normally treated with fear and cause people to stop investing altogether. But the informed investor knows these deals are an opportunity to accumulate more shares at lower prices.
You can buy stocks on sale by investing more money, or you can let the cash dividends automatically purchase additional shares. Either way, the long-term investor shouldn’t fear these price declines but should see it as an opportunity to go shopping for deals.