Markets always go through periods of decline
My career started in 2007 during one of the scariest times in history to invest in the stock market. The S&P 500—the value of the 500 largest companies in America—fell 50% from Oct 2007 to Mar 2009. The media was reporting doom and gloom across the economy as giant banks failed, home prices plummeted, and people were abandoning their homes to foreclosure all around us.
I faithfully put money in the market every two weeks, and consistently watched as my account balance went…nowhere. It was the middle of the Great Recession, the worst economic downturn in almost 70 years. And it turned out to be the best time to invest in my lifetime.
As I write this, the S&P 500 is down over 20% from its peak, inflation is high, and there is fear of a recession and much steeper declines. If you are beginning the ascent on your path to financial independence, and are just dipping your toes into the waters of stock market investing, you are experiencing a situation similar to my own in 2007 and 2008.
Should you keep investing when the market is going down? It’s emotionally difficult, but could be the right decision for you. Here’s why.
Investing when the market is going down
You are probably wondering if you are doing something wrong and if you should wait until the market is lower before you continue investing. You might hear predictions from “trusted” sources that markets will go down another 10%, 20%, or more. But the fact is that no one can accurately predict the future. All we can do is create a solid investment plan and stick to it.
Don’t let fear control your investment decisions. Instead, take the advice of Warren Buffett, one of the greatest investors in history, who famously said, “attempt to be fearful when others are greedy and to be greedy only when others are fearful” in his 1986 letter to Berkshire Hathaway shareholders. This is a concise way of saying that the best time to invest is when markets are going down and the media, your friends, family and coworkers are all thinking about selling their investments out of fear. The opposite is also true: the worst time to invest is when markets are constantly hitting all-time highs and everyone thinks they are gifted investors.
At Pathway to FI, we are buy-and-hold investors and when markets are down we find every dollar we can spare to invest for at least 5 years, if not much longer, and put it to work. In the short-term, markets may continue to decline. In the long-term, those dollars will be some of our most productive investments.
To illustrate, let’s look at what happened following the Great Recession. Figure 1 shows the inflation-adjusted S&P 500 with dividends reinvested, and points out the 20% and 40% dips from the 2007 high.
Every dollar invested in Sept 2008, when the market was 20% below its peak, initially lost another 35% of its value. It then took 3 years to permanently regain its value in Sept 2011. Five years after the investment, in Sept 2013, the dollar grew 45% to $1.45. After ten years, in Sept 2018, it was up 155%. Not bad for an investment that went straight down over the first 6 months!
Every dollar invested in Nov 2008, when the market was 40% below its peak, initially lost another 14%, but quickly and permanently recovered in just 6 months. It then went on to a 5-year gain of 105% and a 10-year gain of 220% in Nov 2018 after accounting for inflation. You cannot afford to miss these kinds of opportunities!
If you could predict the future and put all of your money in at the bottom of the market in Mar 2009, your return would have been excellent. But considering no one can know the exact bottom, you are much more likely to succeed if you just consistently put money in every month or every time you are paid. This strategy is called Dollar-Cost Averaging (DCA).
Table 1 shows what happened if you invested $100/month for one year from the point the market was down 20%. Ten years after the first monthly investment, your $1,200 grew an average of 230% to $3,962. This can be done without any concern for which way the market is going.
If you instead were lucky enough to invest the $1,200 at the exact time the market hit bottom, you achieved a 292% return and grew your money to $4,700 in the same time frame. That is the absolute best you could do. But many people have tried and failed to time the market—including those who make their living looking at financial data. More often than not, they will miss the bottom and make less money than the person who automated their investing and followed Table 1. And who do you think is sleeping better at night?
Stick with time-tested assets (don’t bet the farm on crypto)
Up to this point, I have only discussed one popular asset class, the S&P 500, an index of large cap blend stocks. The points I have made apply to any broad-based basket of company stocks, including smaller companies, international companies, and even real estate and utility company indices. You can also apply these principles to other time-tested asset classes such as gold and government bonds, which have decades of history to analyze performance over many different economic conditions.
I include each of these asset classes in the Pathway to FI model portfolios and describe their performance in more detail in my model portfolio white paper. Read this article for more on the model portfolios.
If you are invested broadly in these types of asset classes, you are on the right track and can focus your attention on earning and saving as much money as you can to continue buying them while they are on sale. If a majority of your “investments” are in speculative assets such as cryptocurrency, NFTs (non-fungible tokens), or a single stock, I cannot make the same assurances.
Blockchain applications such as crypto and NFTs have not been around long enough and do not have any intrinsic value beyond what the next person is willing to pay.
Many of the largest companies that made up the Dow Jones Industrial Average 30 years ago are out of favor today (for example, Sears and Kodak), much less smaller companies that may be out-innovated and become obsolete (I heard you can spend the night in the last Blockbuster on Airbnb!).
Be careful of having too much leverage
In investing, leverage is the process of going into debt in order to purchase more of some asset. If you have two times leverage on a rental house, your mortgage is 50% of the home’s value. In the same way, you can take a loan from a brokerage house and use it to leverage up your stocks, bonds, and other assets. This adds substantial risk, and in a highly volatile market your investments can go to zero very quickly.
If you are two times leveraged on an investment that declines 50%, your investment is worth nothing. If you are four times leveraged, it only has to decline by 25% for you to lose everything.
Leverage may have a place if done prudently in a case such as a rental home purchase, which is something that I did in 2008-2012. But it is not advisable or necessary today for stocks, bonds, or gold.
Summary
Investing when the market is going down can be emotionally difficult.
It’s normal for your investments to go through periods of decline every few years or so. The earlier that you are in your financial journey the better this situation can be for your future returns. If you have a stable income and more than 10 years left before retirement, you should be cheering for the market to go down!
If you’re in retirement or getting close, make sure your portfolio is appropriate for you and read What Should My Asset Allocation Be to take a look at the Pathway to FI model portfolios for the Summit and Descent stages.
Keep investing when the market is going down. You are buying the same companies and assets on sale!
Stick with broad-based market indices with long track records and good historical performance.
Stay away from leverage, which can cause an investment to quickly go to zero.
Keep educating yourself on investing psychology so you can make rational decisions when the economy seems to be going crazy.
Are you on the right path to reaching financial independence? Do you need to make any adjustments to your long-term investment plan today?
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