I think everyone will agree that 2008 was not a good year for the stock market, retirement accounts (including 401k’s and IRA’s) or just about anything else where savings or investing was concerned. The Dow Jones lost more than 33% over the last 12 months and that number has been the focus of a lot of news articles including blog posts. Although I agree that having the market go up makes me feel a lot better than watching it fall almost uncontrollably, there is something that we can focus on that will make us feel better about the state of the stock market.
We Will Survive
This first thing we need to remember is the United States is a very resourceful country. We have weathered bad times in the past and we have always prevailed. This time is no different. Given time, this Bear Market will end and we will again see the return of the Bulls. Until then what should you do?
The most important thing to do is stay calm. Pulling your money out of the market now would not be a good idea. Why? Simple. The market has already lost 33% in twelve months. If you had known the market was going to give up a third of its value before it happened and you got out you would have been a genius. However, now that the market is where it is, let’s find the silver lining.
The Silver Lining
Because the market is down, you can buy shares in just about any company or mutual fund at a really good deal. If you have been systematically adding money to your retirement account each month, you may think that you have lost a lot of money, but that is not exactly true. Right now, as long as your money stays invested in your mutual fund you have what is known as unrealized losses. That means on paper, you have lost money, but until you pull your money out you won’t realize the loss. Here is where things turn positive. If you have been faithfully putting money into your 401(k) or IRA each month you have been buying shares at cheaper and cheaper prices. Right now you have more shares in your account, than if the market had gone up. Why does that matter? Because as soon as the market turns around (and it will) you now have more shares that will be increasing in value.
Let’s suppose you started your retirement account last year by adding $10 a month every month. At the end of the year, you would have contributed $120 to your retirement account ($10 x 12 months). Let’s further suppose that in January, your $10 bought 1 unit of some mutual fund. So, in January, your account was worth $10. Now let’s release the Bear market. For our example, we are going to have the market lose $0.50 each month. At the end of the year, our (hypothetical) mutual fund was selling at $4.50 per unit instead of $10 per unit. A loss of 55%! Because the units in our mutual fund are only worth $4.50, the value of our account is only $79.19. Wait! That isn’t a 55% loss? What is going on? Because the price of the units each month were less than $10, each month we bought more than 1 unit. At the end of the year, we own 17.6 units of our mutual fund.
If we now reverse the trend and this year we see the Bull market return, what happens when the value of our mutual fund start to increase? As you can see from the chart below, if our mutual fund only increases by $0.25 each month, by the end of the year, we will not only have made back all the money we lost in the first year, but our retirement account will be worth more than we have invested. How is that possible? Some call it dollar cost averaging others call it regular contributions, I call it “winning”. You now have 37.6 units of our mutual fund and you have something that you can be excited about. If the market is going down, you can buy more units with the same about of money. As the market goes back up you regain your losses at a faster pace, because you have more units going up in value.
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