Have you ever heard the term “buy low, sell high?”
For those of you who haven’t, this is a simple investment strategy that advocates to buy into the stock market when prices are low and to sell when prices are high.
If we look back at the US stock market, we see numerous occasions where it would have been opportune to buy low.
This strategy has been successful because the stock market has continued to rise over the years. As we can see, there have been some fluctuations along the way, but the long-term trend has always been upward.
How does the stock market keep going up?
In the chart above, the stock market is referencing the 500 largest US-based companies. By being invested in these 500 companies, you can take advantage of the benefits of diversification.
If one company goes out of business, it won’t affect your bottom line because it only makes up a small portion of your investment. Additionally, these 500 names will change over the years as new companies emerge.
We can see how the US stock market has changed by looking at its ten biggest holdings in 1995 and today.
- General Electric
- AT&T Corp
- Royal Dutch Petrol (Shell)
- Phillip Morris
- Proctor & Gamble
- Johnson & Johnson
- Apple Inc.
- Alphabet Inc. Class A (Google)
- Alphabet Inc. Class C (Google)
- Berkshire Hathaway
- JPMorgan Chase & Co
- Johnson & Johnson
There have been many changes over the years, and it’s reasonable to assume that the top 10 will look completely different in the future. As long as the stock market continues to rise over the long term, buying when the market is low will continue to make sense.
Don’t make the mistake of applying this strategy to individual stocks!
When buying an individual stock, you lose the benefits of diversification. If your stock goes down in value, there’s no guarantee it will ever recover. You can buy when the price is low, but if the share price never recovers, it’s a losing proposition.
Companies such as Blackberry, Yahoo, Netscape, Blockbuster, Pier 1 Imports, American Apparel, Compaq have experienced this, and it happens a lot more than expected.
The Russell 3000 Index tracks the 3,000 largest U.S.-traded stocks. Of these stocks, 40% have experienced a catastrophic decline of at least 70% without seeing their share price recover.
You would have been better off holding cash compared to 40% of all US stocks.