Shares are just like any other purchase you make in that you would like to pay less, but usually have to settle for the price on the day.
Once purchased our natural instinct is to see the shares we have purchased continually rising. That way we feel happier and also feel we must have purchased the right shares. But if we are a long-term investor who is reinvesting all dividends and regularly purchasing more shares with the aim of building up a portfolio that gives us a good income in later life do we really want the price of shares higher or lower?
The answer, surprisingly, is lower. We want the market as a whole to be down so that we can purchase our next lot of shares at a cheaper price.
Try and think of it the same way as you would if you were purchasing a commercial building. The lower the price you have to pay the higher your return will be. You certainly wouldn’t sell the building if market conditions made it worth less, in fact purchasing another building at the new lower prices to give a higher return on your money would make more economic sense.
Shares should be looked at in the same way, as with lower share prices your returns will compound at a higher rate. Take the example below:
Say you buy 5000 shares in a well-diversified investment company and the shares cost $2 per share. Over the next year, the company pays you 10 cents per share in dividends. That’s a total of $500 you have to reinvest in more of the companies shares.
If the shares are still at $2 you will be able to buy 250 shares. But if they’ve dropped to $1 you will get 500 shares for your dividend money. If the companies shares stay at $1 for a long period the compounding effect of all these extra shares, plus any further purchases through a regular savings program, will see you well ahead at retirement time.
And, of course, there is always the strong possibility that, if the share price at $1 was caused by depressed sentiment, then at some point it could return to the $2 level.
The longer the market can stay lower for a person saving over 25 years or so the better off they will be in the long run. So don’t get depressed when you see the market down. Smile and continue buying on a regular planned basis.