Wednesday, September 8, 2010

How to keep buying when stocks are cheap

Build up cash when stocks are expensive
When stocks are irrationally high, investors can consider building up cash instead of buying shares in overvalued companies and taking the risks of potentially large paper losses that might take years to recover from, depending on how overvalued the stocks are.

Cash is certainly not king, and investors should never have a large percentage of their portfolio in cash for the long-term, as cash historically generate poor returns. There is nothing wrong, however, in building up cash when there’s nothing attractive to invest in, as having excess cash on hand allow us to take advantage of situations where stocks are trading at a discount.   

Generate passive income
By owning operating businesses, investors get constant cash flows to keep on buying stocks for as long as the stocks stay undervalued. If you do not own operating businesses, you can also generate passive income by having a portfolio of good dividend paying blue chips. An investor can just reinvest the dividends their blue chip stocks generate and let that portfolio compound during normal times, and invest the dividends in undervalued stocks when the market is low (or maybe just keep reinvesting the dividends as the investor’s blue chip holdings might have also dropped to very attractive prices).    

Take on some debt

Investors can consider taking on some debt, as long as the interest on the debt is low, the debt is long-term, and they can easily make the interest payments from their salary or from the cash generated from their operating businesses or blue chips portfolio. To be safe, investors should also have some cash in reserve so that they can  still make interest payments for a while (hopefully they can figure things out in that time) if something happens to their income streams. Investors should always make sure not to take on too much debt, and if they do decide to take on debt, investors need to be sure that they know what they are doing. (I know you probably heard this a million times before, but it’s so important that I don’t mind being the millionth person to state this).

Be frugal, make cutbacks
Investors can choose to tighten their belts and postpone big-ticket plans like going on an overseas holiday, buying a new car, or renovating the house. The cash they save can then be channeled to buying stocks on the cheap.

Investors need to decide which is more important to them; spend less short-term for the potential of bigger future profits or just spend as planned and miss out on being able to pour more money into an undervalued market. To me, this is a personal choice, and neither makes for a bad financial decision.    

If you have any ideas on how to keep buying stocks when they are cheap, or if you have any questions, please feel free to comment.