Buy High and Sell Low?

Down, down, down... the Dow just keeps on falling. The Dow dropped below 7,000 this past week to a 12-year low that represents a 52% drop from its record high in October 2007. Yikes.

Today we see financial writers and commentators wailing and gnashing their teeth, grumbling about how the stock market is currently a terrible place for one's investment funds. As we watch the stock market indexes tumble lower and lower, with no end in sight, many of us are inclined to jump on the anti-stock bandwagon. But wait, haven't we seen this before? Wasn't it like this when the dot-com stock bubble burst, too? The conventional wisdom during financial booms is invariably to buy, buy, buy. And the conventional wisdom following bubble-bursts is always to sell, sell, sell. If you think about it, this is just another way of saying that the conventional wisdom is to buy high and sell low. Say what?

Billionaire investing legend Warren Buffett wrote in his 1997 Chairman's letter to the shareholders of Berkshire Hathaway:

A short quiz: If you plan to eat hamburgers throughout your life and are not a cattle producer, should you wish for higher or lower prices for beef? Likewise, if you are going to buy a car from time to time but are not an auto manufacturer, should you prefer higher or lower car prices? These questions, of course, answer themselves.

But now for the final exam: If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period? Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall. In effect, they rejoice because prices have risen for the "hamburgers" they will soon be buying. This reaction makes no sense. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices.

This means that long-term investors who don't plan to retire within the next few years -- this applies especially to 20- and 30-somethings -- should be happy that the Dow is taking a dive. Not only that, but the lower it goes, the more of it they should buy! Warren Buffett put his money where his mouth is during the 1973-74 bear market, in which he purchased a stake in the Washington Post Company, which subsequently increased in price by a factor of over 100.

Warren Buffett is only one of the many financial titans to have taken advantage of low, low prices during economic panics and depressions. There is a famous quote attributed to 18th century British nobleman Baron Rothschild of the (in)famous Rothschild banking dynasty:

The time to buy is when there's blood in the streets.

The quote is a bit grisly, but it gets the point across. Some people forget that in every transaction -- even during crises -- every seller has a corresponding buyer. When the Dow plunges 52%, that does not mean 52% of the real wealth represented by the stock market has just disappeared. All the shares are still there. All the physical buildings, people, and resources are still there. They have just shifted into a different (usually smaller) set of hands. Wealth has been redistributed. In a panic, the majority of emotion-driven investors sell their stocks to a minority of savvy investors. And those same savvy investors subsequently make a fortune selling those same stocks at a much higher price back to the majority of emotion-driven investors during the next financial boom.

Despite all the wailing about Financial Doomsday, as long as our economy remains capitalist, the stock market is here to stay. As Austrian economist Ludwig von Mises pointed out, there is no capitalism without a stock market. If the stock market disappears, it doesn't matter what you have invested your wealth in -- whether it's bonds, cash, precious metals, or collectable Star Wars action figures -- because that will disappear as well. In the absence of capitalism, the government ultimately owns everything, including you. The death of capitalism is certainly a possibility since the federal government has been nationalizing the U.S. economy in leaps and bounds since the present financial crisis began. But if it happens, it happens -- there is no saving or planning for it.

But if this blatant attack on capitalism by government fails, the stock market will survive. It will eventually bottom out and rise again. It always has and always will. Instead of looking for "safe haven" investments during financial panics, maybe we should consider buying even more stocks as the prices are plunging. The exclamation "What a deal!" doesn't just apply to promotional value meals at McDonald's and after-Thanksgiving sales at Macy's. It applies equally well to stocks after a sharp and emotional market plunge.