Editor’s note: This article was first published in April 2012, during Spain’s recession with the IBEX falling; the view that the bear market was an excellent buying opportunity refers to that moment, and the Apple example reflects its 2012 share price, before the 2014 and 2020 stock splits.
When we give advice on investing in the stock market, we often make the mistake of generalising the criteria we go by, when in reality everyone’s financial situation, and their tolerance for risk, is different. Age matters too: as we have said several times before, making an investment mistake at 20 is not the same as making it at 60, because it becomes harder to recover.
We will now see why today’s market, despite its downward trend, is an excellent investment opportunity. The factors to bear in mind when choosing a share, and when deciding how we invest, are the following.
1. Diversification
This criterion is necessary for every audience and every investor profile. Not putting all your eggs in one basket is no longer an option today but a necessity. Of course, we shouldn’t confuse what diversifying means. Some people think that diversifying an investment means buying (to give an example) 1,000 shares in Telefónica and another 1,000 in Gamesa. Clearly we have spread our capital, but if the whole index falls (the IBEX, in this case), both shares could be hit.
By diversifying, we mean doing it across investment vehicles: one percentage in shares and another in deposits or bonds. That way, we are diversifying our risk. We can also do it across different markets, for example with a percentage in the Spanish stock market and a smaller percentage in companies listed in the United States.
2. Available capital
The amount of capital you start with completely changes the way you invest, as well as the company you are going to invest in. Here is an example: someone who is going to invest €2,000 probably won’t choose the same company as someone who is going to invest €200,000. If you buy Apple shares, those €2,000 would only get you about 4 shares, if that. So however much Apple went up, you would struggle not to lose money.
Starting out with little capital forces you to buy companies whose shares “are cheap”, meaning that with little money we can fill the basket with a good number of them. And if you manage to do that with a cheap company that has potential, it can be a very profitable investment.
3. Short or long term, depending on your age
There are companies that we know will one day be profitable, or at least are very likely to be, such as renewable energy companies. Perhaps one day the regulations will change and we will find these companies rising 1,500% on the stock market. That could happen 20 years from now, and I don’t think a 70-year-old investor will feel like waiting to see it. A young investor, on the other hand, can afford to wait.
Perhaps that older investor would be more interested in a technology company that has just listed and is expected to rise in value over the coming months, or in buying into oil companies, pharmaceuticals or non-cyclical consumer stocks.
Dividend payments: Likewise, while an older investor will probably look for an investment that pays off in the short term, a young investor can invest for the long term without paying too much attention to the current state of the market, and make the investment worthwhile through dividend payments.
4. Opportunity in today’s market
The Spanish market is clearly heading down. Here we can follow one of Warren Buffett‘s pieces of advice: look for companies trading below their value; look for companies that are undervalued or going through a temporary rough patch.
That is exactly the situation on stock markets during a recession, because practically all the companies in the index (with a few exceptions) are trading far below what they were worth and/or will be worth in 4 or 5 years (always assuming the crisis gives us a break). Some companies will never get back to the share price they had five years ago; others will exceed it by far. It is a matter of studying which companies will come out of this recession stronger and which will never recover once it is over.
There is no need to be afraid, although you should take more precautions given how volatile the markets are right now. Even I, who have never been a fan of using stop orders, now have them on some of the companies I hold, because you can’t rule out the kind of news that could arrive at any moment.
These are some of the most basic concepts to bear in mind when investing. Above all, know what we are hoping to achieve and what we expect from our investment, and get used to the idea that we are investing for the long term, because in the short term things don’t always go as we expected, and that is no reason to lose our calm.
Further reading
- Falling stocks: sell, buy or hold?
- How to make more than $1 million in 12 years
- Why do share prices go up and down?
- Investing in the stock market for beginners
Featured image: Edgar Degas, Public domain, via Wikimedia Commons.
