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"A Vision of Financial Security"

Money is Made in Bear Market  By A. Raj Kumar          May 16, 2008

Warren Buffett, one of the most successful investors of all time, has a saying that is relevant today.  He says that most people invest by looking in the rear view mirror.  What he means by this is that most people look at the most recent past and assume that the trend will continue.  So when the stock market was rising day after day, week after week, month after month, and year after year from 1995 to 1999, everyone assumed that this trend would continue indefinitely.  What most people did not realize was that as the prices rose higher and higher, the downside risk grew bigger and bigger.  The price of most stocks had much greater room to fall.  So when the prices began to fall, that is exactly what happened.  Prices fell dramatically; in many instances the stock price fell by 90%, 95% and even 99% (think Lucent!).

 

             Most investors are making the reverse mistake now.  In July, stock mutual funds collectively had the largest redemption month ever; $52.6 billion dollars worth of mutual funds were redeemed.  These investors panicked and sold at the bottom!  They are looking in the rear view mirror again and assuming that the downward trend in stock prices will continue indefinitely.  What they are forgetting is that the dramatic fall in stock prices just eliminated their downside risk!  Investors need to look ahead and see the upside potential.  They need to realize that the stock market always recovers eventually and that their stocks will once again trade at higher prices.  What better time to buy than now when the prices are at rock bottom lows!

 

             Wall Street has many truisms and one of them is that money is made in bear markets.  In my opinion, this saying is absolutely true.  Investment profits is obviously the difference between the sold price and the buy price.  The lower the buy price the greater the profit the investor can make.  So by buying stocks at the currently depressed prices, he is increasing the amount of his future profits.  When this investor eventually sells, say in 5 to 10 years from now, the stock price will certainly be much higher.  I am assuming that he is buying the stock of a high quality company (e.g., Microsoft, Intel or Merck) that will be around in the future and not go bankrupt.  What he has just done is follow the most famous of all Wall Street truisms: buy low and sell high.

 

             Finally, the most successful investors are true contrarians.  They always go against the crowd.  By buying stocks now, you will be in their camp and have a shot at making great returns like them in the future