From Greg Wilson, chief analyst, the Legacy Portfolio: What if the price of the new car you want to buy suddenly dropped by 30%?
That would get me to buy.
But a funny thing happens when the same thing occurs with stocks. Investors get scared and head to the sidelines.
We saw this in 2008 when investors withdrew $234 billion from stock funds. The funds didn’t have positive inflows again until 2013. By then, prime buying time was over. The market was nearing its prerecession highs.
Here’s the real secret to accelerating your investment returns: When you own a legitimate world-class business, buy more when the market takes a turn lower.
[Now, I know this advice sounds somewhat contradictory to PBRG’s risk-management protocol: the Palm Beach Three-Legged Stool of Safety. For most equity positions, we hedge them by maintaining trailing stop losses. If our capital falls lower than our stop loss, we sell. Preservation of capital is our No. 1 priority.
But the Legacy Portfolio—our collection of world-class companies that can survive the greatest downturns—are a special exception to this rule.
These companies have survived world wars, depressions, recessions, oil shocks, gold shocks… every volatile economic condition you can imagine. Their businesses are just that powerful and resilient… and that makes them the safest equities on the planet.]
Most people are afraid to buy when the market tanks… but you shouldn’t be. Stock markets always recover:
On October 19, 1987, the Dow Jones Industrial Average fell 22% in a single day… the largest one-day percentage decline in history. However, few remember the Dow recovered—and marched 15% higher—over the next four months.
When the New York Stock Exchange reopened for trading after the 9/11 attacks, the market crashed 7% that day. It quickly recovered. The U.S. stock market was up 12%… again, just four short months later.
In the recent stock market meltdown of 2008-2009, the broad markets reached their bottoms in March 2009. But just a year later, the S&P 500—a basket of the largest U.S. stocks—was up 70%.
If you had the smarts and the courage to buy Legacy stocks when everyone else was selling or too afraid to buy… your “average” cost of those stocks would be much lower than everyone else’s.
Let’s take a look at how one decision can improve your returns by 26%.
We’ll examine two investors, John Legacy and Mary Fearful. Both buy shares of Coca-Cola at the beginning of 2008. They each buy 100 shares at $30.73 per share (total spent per person: $3,073).
During the 2008-2009 Great Recession, the S&P 500 declined 51.8%. Coca-Cola shares declined 35.4%. John Legacy decides to invest another $5,000 in Coca-Cola.
Because he has the courage to buy at this point, he’s able to buy another 255 shares with his $5,000.
Mary Fearful, however, is too afraid to buy more shares of Coca-Cola during the crash.
Instead, she waits until January 2010, as the market recovers—and she feels it’s safe to invest again.
By then, shares of Coca-Cola trade for $27.58, which means Mary is only able to buy 181 shares with her $5,000.
Fast-forward to the end of 2012. Both John and Mary have now been invested in Coca-Cola for five years. The stock is trading for $36.25 per share.
Mary Fearful has a total of 281 shares of Coca-Cola, for a total value of $10,186.
But John Legacy has a total of 355 shares, for a total value of $12,869.
Mary’s average cost for her two Coca-Cola share purchases is $28.70. John’s average cost for his two Coca-Cola share purchases is lower, at $22.70.
John’s account size is 26% larger than Mary’s… all because he understood the concepts behind Legacy investing. They empowered him to buy more shares in a world-class company at an opportune, though scary, time.