Thursday afternoon as I stared at my computer screen awash in “up” arrows after three days of stock market rallies and over 21% in gains, I saw a headline pass that read something like, After the fastest bear market in stock market history, we have entered the fastest bull market in history.
But the next day the Dow Jones industrial average fell just over 4%.
Welcome to the most volatile market in memory.
When volatility is minimal and stocks are rising, 401(k) investors are forced to pay ever-higher prices. But when volatility reigns, like now, 401(k) investors can actually benefit from adding to holdings in great companies that are suddenly selling at a discount.
What holds investors back are the frightening days when stock prices dive. When everything is selling — when panic sets in — it is difficult to invest. The old adage, throwing good money after bad comes to mind. But remember how the game works with big institutions driving short-term trading. They employ program trades driven by computer-generated algorithms to trade baskets of stocks in massive volumes —sometimes as much as half of the daily volume at the New York Stock Exchange. This means that in the short-term, the trading programs, not necessarily the underlying fundamentals, drive stock prices.
Buy as stocks prices fall
This is when volatility can potentially be your friend. If you are contributing to a 401(k) on a regular twice-a-month pay cycle, say the first and the fifteenth of the month, you are adding to your existing holdings at different prices. This is called dollar-cost averaging.
For purposes of showing how volatility can help you, consider that the price on the SPY (an ETF designed to track the S&P 500) on December 31, 2019, was $321.86. By the end of February, the SPY was trading at $297.51. For the same contribution you would have received around 8% more shares in late February than you would have in late December.
Then, by March 13, the SPY was trading at $269.32. Compared with the price at the end of the February, you would have received approximately 10% more shares.
As unnerving as falling stock prices are, remember that buying more shares puts you in a stronger position when the prices start to rise again.
The concept is simple but rarely the way we see things when markets are in seeming free-fall. If you invest outside your 401(k) you should employ the same dollar-cost averaging strategy if at all possible.
Don’t be tempted to buy after a three-day streak like the one we saw last week, rather be disciplined and add slowly. Markets have a bad habit of falling further. But, if history is any guide, stocks will eventually achieve their previous highs. And then some.