NEW FLASH: MARKET IS DOWN
By Selena Maranjian (TMF Selena) August 3, 2006
You didn't need my news flash to know that the market is down. After all, you've probably seen some red in your portfolio of late. Yet one of the most important concepts that we investors need to understand is this: The stock market, especially in the short run, goes up and down. And while it can be unsettling and even alarming to see our holdings drop in value, we needn't freak out.
That's particularly true if we're constructing a sensibly diversified portfolio. In fact, if you've been hard at work building a particularly good portfolio, then you might actually be welcoming this downturn. Permit me to explain.
Learn from the masterThis is from master investor Warren Buffett's 1997 letter to shareholders:
A short quiz: If you plan to eat hamburgers throughout your life and are not a cattle producer, should you wish for higher or lower prices for beef? Likewise, if you are going to buy a car from time to time, but are not an auto manufacturer, should you prefer higher or lower car prices? These questions, of course, answer themselves.
But, now for the final exam: If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period? Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall. In effect, they rejoice because prices have risen for the "hamburgers" they will soon be buying. This reaction makes no sense. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices.
Got it? Good. Here's a real-life example. Over the past three months, the S&P 500 has slumped approximately 3%. In that same period, many individual stocks sank further. Home Depot (NYSE: HD), for example, is down more 13% and Netflix (Nasdaq: NFLX) is down nearly 40%. Some of these declines are due to the market's irrationality, while others may be warranted. Netflix, for example, looks like it has some struggles on the horizon.
Buying lowsDespite these drops, as Buffett advocates, many professional investors are swooping in to buy. What's more, we've been telling individual investors to do the same.
But what if you don't know how to separate the irrational drops from the warranted drops? Well, I've got good news for you. You can put professional investors to work for you in this opportunistic market by buying shares of top-notch mutual funds. These are folks who have lots of experience in the market and spend all day every day researching the best ways to make you money. Even better, as stock valuations fall so do mutual fund valuations.
Consider, for example, an international value fund that Fool fund guru Shannon Zimmerman recommended in June 2006. While it's down more than 9% in just a short period of time, that's no reason to worry. In fact, there may be reason to celebrate, if you're thinking of buying some shares. The seasoned value hounds running the fund have more than 20 years experience, and investors can rest easy that they'll be figuring out ways to make money from cheaper stocks. And if you're curious, this fund's recent top holdings included Jones Lang LaSalle (NYSE: JLL), Markel (NYSE: MKL), HCC Insurance Holdings (NYSE: HCC), Investors Financial Services (Nasdaq: IFIN), and Career Education (Nasdaq: CECO).
The Foolish bottom lineOn days or months when the market has taken a beating, remember that can mean there are special opportunities out there. What looks like bad news can actually be good news for you.