Friday, May 16, 2008

Long term Investing during down markets

People are always looking for ways to make money. In a uptrend market no one wants to miss a boat and in a downturn is always about how can I recover the lost dollar.

Investing during down times could be hard especially around the pessimism that may surround the news. It's been said that more or most returns could be fetched by investing in a downturn.

Although past is not an indicative of the future lets take a look at examples of investing in some bear markets in the past and how investing during bear markets can have profits of its own.

The rule is start systematic investments(SIP) for every specific period in a bear period until the next positive trend or until the value at last instance is lesser than the current one.

Let us start with the oil crisis in 1973 which started around October 1973 which further led the downfall to the stock market. Assumption is that one started investing in the NASDAQ index back in June 1973 in a systematic investment plan until say September of 1974 . Between this period the NASDAQ went from 108.54 to around 59 with SIP of $100/month. For a period of 15 months this would mean an investment of $1500 with an average price of $84 for the index with roughly 17,85 shares.
courtesy:finance.yahoo.com

Lets consider the same investment plan for investments into savings account at the same timeframe with an average of an savings interest rate from 10% to 6% (source http://en.wikipedia.org/wiki/Image:Federal_Funds_Rate_%28effective%29.png ). This is effectively money wit 8% rate of return for a principal of $1500.

Lets first have an investment period of 5 years by which the NASDAQ index went up to around 130 which (not inflation adjusted) is an increase of roughly 54%. This money will now be taxed
Our initial investment now in the share market is worth around $2321 (which after tax will be $2115) whereas our money in the bank would have grown to around $2007 with the assumption that the tax bracket is 25% and the money is kept in an after tax account. The net (compounded interest) gain here is 33%.


This is money I consider good for a long term investment (5- 10 years) vs. a very long term (more than 10 years) investment.

Applying the same hypothesis to other bear markets in the past from 2001 - 2003 and the 1979 energy crisis yielded promising results. A larger bear market meant more time to stay put into the SIP but saw good yields thereafter.

There are some assumptions made in this theory: Investor is starting to invest in the fund at this point or does not already have an SIP in the same fund from an earlier time.

In my second article I will try to analyze if buying during a bull market is lucrative. Stay tuned and let me know your thoughts.

The bear market investing for longer term looks to be lucrative.

2 comments:

finance ninja said...

Simple. Do what Warren Buffet does, but doesn't talk about.

Buy Put options for insurance on all your stocks when downtrend is likely to continue, sell puts when trend discontinues. Now you are breaking even or up +% for the year. Which is why he continually has a positive increase even in bear years.

Tapan said...

Ninja, Thats correct. for that one needs to correctly pin point the downtrend. One can become an expert and then definitely explore the option.