Should You Invest During a Financial Crisis?

Written on 10/13/2008 by Michael Miles. Michael writes about personal growth, communication, and increasing personal wealth at Effortless Abundance. You can download his book, Thirty Days to Change Your Life, for free.

Photo Credit: sjsharktank

It seems that everyone is running away from the stock market these days. This morning on the news, I heard an ‘expert’ say that investors had ‘given up’ on stocks, that they were getting out, selling up, and that this was pushing the stock market down even further.

So why on earth would anyone recommend buying stocks at a time like this? Well I for one believe that now is one of the best times ever to invest in stocks. Here’s why.

Invest in stock
In his now classic book Stocks for the Long Run, Jeremy Siegel shows that stock market returns are very stable over the long term and outperform every other asset class over time. Despite enormous social, political and economic upheavals over the past two centuries, stock market returns have been extremely predictable in the long run. Through two world wars and numerous other conflicts, through the great depression, Black Monday, terrorist attacks and all manners of natural disasters, the long term payback provided by owning stock has been predictable and consistent.

It might seem like the end of the world now, but it isn’t – the economy will recover, the market will recover and stocks will continue their predictable path.

Don’t follow the crowd
It’s hard to invest in stock when everyone else is selling. By nature, we are social creatures and we don’t want to stand out from the crowd. So when the crowd is full of fear and is running away from the market, it takes courage to walk in the opposite direction. But, as Warren Buffet famously said, the successful investor should be ‘greedy when others are fearful and fearful when others are greedy.’ This is not to say that we should be throwing our money away on stock in companies with a seriously impaired outlook, but there are many, many companies with excellent track records of profitability and growth, strong management teams, excellent product lines, and innovative R&D, which have been dragged down with the general market to very low prices indeed. It is not my intention to give any specific stock picks, but there are some great buys out there.

Unlike so many other things, stock can be valued, and in many cases market prices have gotten way out of line with what shares in companies are worth. Of course, when stock rises to a price which far exceeds its value, it may be time to sell, but the market we are in now is a bargain bucket for discerning buyers.

Treat stock as ownership in a company
There is a tendency for some people to regard the stock market as a giant slot machine. People will throw money into the market and pray their stocks’ will rise in value. But this is not investing. To invest is to regard your stock as a source of future cash flow. Ask yourself – how much money will ownership of this company make me over the next several years? If you’re time horizon is a week or two, you are trading stocks, not investing.

Buy the right stock
Apart from buying at the right price, you need to buy companies which will continue to prosper (i.e. make money for you) well into the future. None of us has a crystal ball, of course, but here are some features which you ought to look at when considering a stock investment. These are just some pointers to get you doing more research.

• Companies which dominate their market in some way. This dominance, or ‘economic moat’, could be (for example) a strong brand, a large network or high costs involved in switching to another service provider. These moats make it hard for competitors to get a foothold and make it more likely that the company will stay financially successful.

• High return on equity. It is a measure of how well a company uses invested money to generate growth in earnings. A high ROE can be a sign that a company has a moat. 

• Consistent and rising dividend payments can be a sign that a company is consistently making money. 

• Companies which operate outside the US. Warren Buffet and others believe that the growing US trade deficit will devalue the US dollar in the long term and so it is prudent to have some exposure to companies which operate in other markets.

These measures are the tip of the iceberg, of course. If you are serious about investing in stock, you’ll have to do some more drilling.

Invest for the long term
Someone once asked Albert Einstein to name the most powerful force on Earth; he said ‘compound interest.’ The power of compound interest is truly astonishing. If you invest $100 per month from age 25 at 8% per annum, by the time you’re 65 you’ll have $337,000. At 10% per annum, this becomes $585,000. If you double your savings to $200 per month, you’ll retire at age 65 with $1,171,000. To achieve the same result starting at age 45, you’d have to invest more than $1,500 per month. It’s never too late, of course, but it’s always better to start young. So don’t waste valuable time – get investing.

Expecting an 8% annual return from the stock market over a long period of time is not unrealistic. The stock market has historically returned more than this over almost all 20 year periods since 1802.

One of the easiest ways to invest in the stock market is to buy shares in an Exchange Traded Fund (ETF) which seeks to emulate the performance of the broader market. This requires little knowledge about stocks and will, in the long run, virtually guarantee you returns which are superior to any other kind of investment.

Conclusion
It turns out that investing in a financial crisis is no different from investing at any other time, except that more opportunities abound for those with the right temperament. An interesting final statistic – an investor who put $15 per month into good common stocks, starting in the summer of 1929, just before the start of the ‘great depression’ of 29-32, would have made 12.72% per annum over the next 30 years. What’s not to like about the stock market?

Michael