Sale Tags

Should You Wait for Stocks to “Go on Sale”? Not Necessarily

There’s nothing shoppers like more than a good sale. Buying what you want at 10% off, 20% off or even a higher percentage discount feels like a rewarding experience–a conquest of sorts. When you bring home a bargain, you may feel you’ve “outsmarted” the market. Retail stores know this, so they actively practice a range of sale strategies, from discounts on a few specific items to store-wide sales that apply to everything.
You may wonder: Is it possible to get discounts and therefore outsmart the stock market? What sorts of bargains can you get on stocks, and is it smart to wait for a stock “sale” before investing?

This is a very timely question. As of June 2015, the S&P 500, an index that measures the stock values of America’s largest companies, is near its all-time high. So would investors with cash in hand do better by waiting for a “sale,” or decline in stock prices, before fully investing in the market?

To explore this important question, we looked at the performance of the S&P 500 over time and tested two different strategies. One investor–we’ll call him the Bargain Hunter–had $1,000 to invest in the S&P each month. But he had a plan: If the index was within 10% of its all-time high, the Bargain Hunter held onto his cash and let it build up, earning an interest rate on it equal to the yield of a three-month Treasury Bill. Alternately, whenever the S&P 500 fell at least 10% from its all-time peak, the Bargain Hunter put all of his accumulated cash to work to take advantage of the “stock sale.”

Our second investor–we’ll call her the Long-Term Investor–had the same $1,000 to invest in the S&P index each month. However, rather than waiting for a decline in prices, she invested her cash immediately and systematically each month.

So, who ended up being savvier: The Bargain Hunter or the Long-Term Investor?

By following her consistent strategy from January 1980 through the end of May 2015, the Long-Term Investor came out ahead. Her portfolio grew to be worth about $261,000 more than the Bargain Hunter’s portfolio (see chart below).

Are you scratching your head? We know: It may seem a little counter-intuitive that the Bargain Hunter’s strategy didn’t actually result in stronger returns. After all, wouldn’t waiting for stocks to go on sale be a smart way for the Bargain Hunter to make sure he bought them at cheaper prices?
The problem with this concept is that stock prices often go up for extended periods of time, hitting new peaks month after month. For example, in the 1990’s, the S&P 500 went on an 81-month surge from February 1991 to October 1997 without a single 10% decline. There was also an extended period in the 1980’s when stocks went 39 months from August 1984 to October 1987 without suffering at least a 10% decline. The Long-Term Investor, who continued to invest throughout this time, benefited from owning these increasingly valuable shares. The Bargain Hunter, who held onto his cash waiting for the occasional sale, missed out completely on these rallies.

Many bargain hunters are facing a similar dilemma today. The stock market has not been at least 10% below its peak since 2011, when a crisis spurred by Congress’ inability to come to a compromise on the federal debt ceiling caused a plunge of over 10%. As of June 2015, it has been over three years since the last time the S&P 500 was at least 10% below its all-time peak.

Stocks on sale

Of course, stock prices don’t always rise. There have been extended periods during which stock prices were essentially flat. For example, after hitting a new relative peak in March, 2000, the S&P 500 went through two bear markets and has only recently approached and eclipsed that prior peak.

This sounds like a period when the Bargain Hunter could have really come into his own. As such, we studied the same two strategies with a starting point of January 2000 to try to test whether that might be true. It turns out that the two strategies end up performing quite similarly over this period, with the Bargain Hunter ending about $5,000 behind the Long-Term Investor.

By investing $1,000 each month starting January 2000 and ending May 31, 2015, the Long-Term Investor’s portfolio grew to about $372,000 (see chart below). By comparison, the Bargain Hunter, who waited for at least a 10% decline before investing his cash, saw his portfolio grow to about $364,000. In the volatile market with two big declines, the Bargain Hunter didn’t miss out as much in the rallies. However, he still faced a few extended periods of being under-invested while waiting for bargains, which took away all of the advantage he earned by waiting for sales. These results suggest that the Bargain Hunter’s strategy is one that may reduce returns in markets that are rising without providing much additional value in weak, volatile stock market environments.

We should say, however, that as strategies go, bargain hunting may still be better than having no strategy at all. Any investor who avoided the market altogether out of fear and stayed completely invested in cash missed out the most of all. Putting $1,000 per month into an account that earned an interest rate equal to a three-month Treasury Bill starting in 1980 would have given a reluctant cash investor about $789,000 over the full time period. This method under-performs both the Long-Term Investor’s and the Bargain Hunter’s strategy by more than $3 million! And even over the low-return, volatile period that began in 2000, the cash investor’s portfolio would have only grown to $200,000–again under-performing both of the other strategies.

Stocks on sale

What’s the lesson here? Bargain hunters, whether they dabble in stocks or in retail merchandise, sometimes run the risk of missing out. Their target investments or coveted consumer goods can get away from them and actually rise in price while they sit back wait for sales. On the other hand, long-Term investors who put their cash to work consistently, every month as they earn it, are the savvier stock shoppers in the end.

Do you need help transitioning from being a Bargain Hunter to becoming a savvy Long-Term Investor? Give your Wealth Advisor a call. We’ll show you how.

Data Source: Bloomberg

 

Important Disclosure Information

Please remember that different types of investments involve varying degrees of risk, including the loss of money invested. Past performance may not be indicative of future results. Therefore, it should not be assumed that future performance of any specific investment or investment strategy, including the investments or investment strategies recommended or undertaken by RegentAtlantic Capital, LLC (“RegentAtlantic”) will be profitable. Please remember to contact RegentAtlantic if there are any changes in your personal or financial situation or investment objectives for the purpose of reviewing our previous recommendations and services, or if you wish to impose, add, or modify any reasonable restrictions to our investment management services. A copy of our current written disclosure statement discussing our advisory services and fees is available for your review upon request. This article is not a substitute for personalized advice from RegentAtlantic. This information is current only as of the date on which it was sent. The statements and opinions expressed are, however, subject to change without notice based on market and other conditions and may differ from opinions expressed in other businesses and activities of RegentAtlantic. Descriptions of RegentAtlantic’s process and strategies are based on general practice and we may make exceptions in specific cases.

The first chart in the article plots the terminal value on May 31, 2015 of two hypothetical portfolios. The Long-Term Investor portfolio invested $1,000 into the S&P 500 index each month starting January 1980 and earned the index’s total return with dividends reinvested. The Bargain Hunter portfolio accumulated $1,000 per month and would only invest it into the S&P 500 if the index’s total return was at least 10% below its all-time peak. If the S&P 500’s total return was within 10% of its all-time peak, the Bargain Hunter portfolio kept its cash and invested its $1,000 per month into 3 month T-bills, earning a rate of return equal to their yield at the time. Whenever the S&P 500 total return index fell more than 10% below its all-time peak, the Bargain Hunter portfolio took all accumulated cash and interest earned and invested it into the S&P 500, and earned the index’s total return with dividends reinvested.
The second chart plots the terminal value on May 31, 2015 of two hypothetical portfolios. The Long-Term Investor portfolio invested $1,000 into the S&P 500 index each month starting January 2000 and earned the index’s total return with dividends reinvested. The Bargain Hunter portfolio accumulated $1,000 per month and would only invest it into the S&P 500 if the index’s total return was at least 10% below its all-time peak. If the S&P 500’s total return was within 10% of its all-time peak, the Bargain Hunter portfolio kept its cash and invested its $1,000 per month into 3 month T-bills, earning a rate of return equal to their yield at the time. Whenever the S&P 500 total return index fell more than 10% below its all-time peak, the Bargain Hunter portfolio took all accumulated cash and interest earned and invested it into the S&P 500, and earned the index’s total return with dividends reinvested.

Please note that these hypothetical portfolios are NOT intended to illustrate the investment results that were actually achieved or could have been achieved by any of our clients. The portfolios do not reflect the deduction of fees and expenses that a client would incur, which would have the impact of reducing the returns of each portfolio. Information regarding RegentAtlantic’s wealth management fees is provided in its Form ADV Part 2. These portfolios are intended to show the potential differences in two types of investment approaches.

Indexes Used:

S&P 500: The S&P 500 is an index consisting of 500 stocks chosen for market size, liquidity and industry grouping, among other factors. The S&P 500 is designed to be a leading indicator of U.S. equities and is meant to reflect the risk/return characteristics of the large-cap universe. Each constituent in an index is weighted by its market-capitalization, as determined by multiplying its price by the number of shares outstanding after float adjustment.