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It is a rare moment in history when people all over the world are glued to news sources, watching in horror as events unfold by the day, even by the hour.
We have watched with ever growing awareness the global, national, and deeply personal impact of today’s current events.
And then we wake up to headlines like this one from The Wall Street Journal: Dow Plummets Nearly 3,000 Points as Virus Fears Spread”.
Amid these growing concerns and the reality of a stock market crash and potential recession, how should we react or prepare?
What does a plummeting stock market mean for your investments, your retirement health and your financial future? What should you do during a stock market scare?
To start off, think about one question:
How does your net worth today compare to your net worth 5 years ago?
Don’t run to your computer or pull up your investment apps just yet. But think of a rough estimate, then read on…
First, understand why the market is tanking
We are entering a new chapter of history, one that no one has ever experienced before. And that is scary.
I’m writing this on March 16th, 2020 and in the last week alone the S&P 500 has dropped 12%. Total year-to-date loss, over 26%.
We’ve been expecting a downturn, but not one this sudden and in the wake of a national pandemic and turmoil in the oil industry.
The fact is, people are scared. And when people are scared, the stock market reflects this. As investors become uncertain, they sell investments in an effort to hold more cash. This leads to a sudden and volatile drop in the stock market.
Historic volatility
To put things in perspective, here is a timeline of past stock market crashes, both how much the market dropped and how long it took to recover.
The Great Depression of 1929:
- The Dow fell 89% over a period of 34 months
- It took about 25 years to recover
Black Monday of 1987:
- The Dow fell 22.6%, the largest drop in a single day. Markets continued to drop by a total of 31% over 3 months.
- Markets recovered just under two years later
Recession in the 2000’s:
- Market drop of 34% over 43 months
- It took about 4 years to recover
Housing crisis and Great Recession of 2007-2008:
- Market drop of 49% over 16 months
- Again, it took about 4 years to recover
Coronavirus pandemic and oil price wars of 2020:
- Dow Jones drops 28% between February 11 and March 12
Another Black Monday?
On Monday, March 9th, all three Wall Street indices fell by more than 7%, marking this the worst drop since The Great Recession of 2008. However, shortly after the opening bell on Monday, March 16, trading was halted after another rapid 7% decline. All three indices fell by more than 12% and the market closed with historic lows.
The Dow is down 29% so far this year, with its largest point drop in history.
The S&P 500 and Nasdaq are down 29% from the record highs just last month.
What does this look like? It looks scary.
It looks like you need to react quickly and pull your money out before you lose it all.
S&P 500 over the last three months
What this means to the long-term investor
But what does a market crash really mean for the long-term investor? It helps to zoom out a bit and gain a little perspective.
The thing is, we are in this for the long haul, meaning a minimum of 5 years, preferably 10, 20 or even 30 years before retirement. That massively scary drop in the market we all just witnessed today, it is one day in history.
But when you look at the history of the stock market, a steep decline one day blurs into the overall upward trend of the market over time.
Don’t panic during a market crash – you’re in this for the long haul
Here’s a look at the S&P 500 as we zoom further and further out over history.
YTD
Yes, it looks horrible and scary. It looks like you were doing great going into the year and then suddenly, a very large percentage of your net worth just disappeared.
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1 Year
Yes, it still looks horrible and scary. Your net worth just tanked by some unknown amount.
2 Years
Now we see a little perspective. Our investment accounts lost value, but we are right where we were in December of 2018.
Whatever your net worth was, what was tied to the stock market anyway, is about where you are now. It may feel like it, but you did not lose years worth of hard earned money.
In fact, assuming you continued to make regular contributions to your retirement / investment account, you now own more shares than you did in 2018. They may have lost value, but you still own more of them. We will revisit this a bit later.
5 Years
Once we zoom out a full 5 years, things don’t look quite so scary anymore. Yes, we just lost a lot of value. But overall, we are still well ahead of where the market was 5 years ago.
Notice that even the drop in December 2018 is an increase over the previous years.
There is still a steady overall increase in value. The 5-year return was 9%.
10 Years
And as we continue to zoom out, you can see an overall growth of the market. The 10-year rate of return was 12%.
20 Years
As we look out over 20 years of stock market history, we can see the recessions of 2003 and 2009. More importantly, we can see that we did in fact recover from these recessions and continue growing over time, even with the current market crash.
30 Years
Even with our current crash, it looks more like a small blip in a relatively smooth graph that continues to increase over time.
What to do if you still can’t handle stock market ups and downs
First, it’s quite possible that this just isn’t your form of investing. And that’s okay. You could start a business or invest in real estate. There are other forms of investing out there.
However, if you want to contribute to a retirement investment account, which is important to do as a supplemental and diversified investment strategy, I highly recommend you read the book The Simple Path to Wealth: Your road map to financial independence and a rich, free life
. JL Collins does an excellent job describing how the stock market works, how to invest for the long term, and how to feel comfortable setting it and forgetting about it. It truly is the simplest path to wealth.
All time history with recessions
The grey areas on this graph represent the various recession we have experienced throughout the history of the stock market. Some lasted longer than others. All had an impact on those that experienced them.
For those who can wait it out, diversified investment accounts, such as total market ETF’s, do recover and continue to increase in value over time.
Don’t touch your investments
If we look at the S&P 500 over time, while it fluctuates year to year, since inception the average return is 10% – 11%.
10-year returns on my favorite ETF, Vanguard’s VTI, is just under 12.5%. This is a long game. These same shares are currently down by 16%, but over time, they will go back up.
Some years see dramatic growth. Some years see just the opposite.
The market is volatile. If you are simply too emotionally tied to the ups and downs and you can’t stomach watching the numbers change day-to-day, month-to-month and year-to-year, then this isn’t the form of investing for you.
But if you’re in this for 5 or more years, and you’re willing to see the bigger, zoomed-out picture, history tells us that you will end up ahead.
Realized vs. Unrealized loss
Aside from the bigger picture, it’s important to understand the difference between realized and unrealized loss.
Yes, we just experienced a dramatic market crash. But have we actually lost anything yet?
Unless you hand pick individual stocks and those companies fail, the answer is no.
Note: This is why I believe in investing in broad exchange traded funds (ETF’s), representing the entire stock market, rather than individual companies.
So long as you do not sell, you have not lost anything. You have experienced an “unrealized loss” in the value of the shares you own. But you still own the shares. You have only realized a loss if you sell at a loss.
Example of realized vs. unrealized loss
Let’s say you have an investment account with Vanguard and you buy 100 shares of VTI. The value at the time of purchase is $100.
100 shares x $100 = $10,000 value
Then, you see the market begin to drop.
Now you’re worried and feel the need to sell your investments before they drop even further. The shares are now worth $80 and you sell at a 20% loss.
100 shares x $70 = $7,000
You have effectively locked in your $3,000 loss.
Once the market corrects, shares go back up to $100 so you buy back in, but you can now only afford 70 shares instead of your original 100.
As the market continues to go up, that loss of 30 shares will have a greater impact.
But what if you hadn’t sold in the first place?
You originally had 100 shares worth $100. They dropped all the way down to $50 per share. But you stayed the course and didn’t sell. Even at $50/share, you still owned 100 shares.
Over time, the market corrects and continues its historical growth. Your VTI shares are now valued at $130/share, which leaves your portfolio value at $13,000.
For the person that sold and only has 70 shares, their portfolio value is $9,100. That’s a difference of $3,900, greater than the original $3,000 loss upon selling early.
This is why, if you are investing for the long term, it is best to not touch your investments. You own your shares, you only lose them when you sell. Any drop in the market is an unrealized loss.
The benefit of a market crash – buy at a discount
It may not feel like it, but there is a benefit to these volatile market conditions.
Everything is on sale right now.
Assuming you make consistent contributions to your retirement and investment accounts, now is a great time to keep making these contributions as usual. During a market decline, every dollar invested buys more shares than you were able to purchase before.
Better yet, if you can afford it, now is the time to be investing.
Remember those 100 shares you bought for $100 each? If they are now valued at $50, you can afford to purchase twice as many. When the market corrects, as history has demonstrated time and time again that it will, you will come out ahead in the long run.
Your retirement account is like a money making machine
The goal of contributing to your retirement and investment accounts is to grow your money so that you can one day live off the interest earnings. For example, if you need $40,000/year to retire and you have $1 million in your retirement account earning roughly 4% interest each year, you can safely withdraw your $40,000 living expenses without depleting the principal value.
In this sense, your job, up until retirement, is to build a money earning machine that will manufacture your living expenses. Every share you purchase through your monthly and annual contributions can be thought of as purchasing parts to build this machine.
Eventually, you will have enough parts that it will be a well oiled machine, pumping out retirement income.
When the market is down, it’s easy to feel like your machine just broke. You just lost half your parts and you’re left with the overwhelming task of slowly building your machine back up.
In reality, nothing happened to your machine. All the parts you have worked hard to build are still there. Every last one of them.
Better yet, parts are on sale right now. Which means, now is your opportunity to buy more of the parts you need to keep working on that machine.
During a market crash, don’t pull out your investments. Buy them at a discount.
Yes, it may take the market a long time to recover. It may take extra years before you can retire. But if you have the time to wait it out, you will end up ahead.
What if the market crashes and never recovers?
In the history of the stock market, this has never happened. However, if it did, we’d have bigger problems to worry about.
We would be in a virus ridden apocalypse and it just wouldn’t matter. No one would have money, the value of money wouldn’t exist, the stock market wouldn’t matter.
What if you are retired or about to retire?
Consistency is key. Just as you consistently contributed to your retirement account all these years, in retirement, you consistently withdraw only what you need on a monthly basis.
Small amounts over time, rather than selling out of fear, will safeguard the overall value of your account. Your money will keep working for you and the market will increase again over time.
Stay the course. If you are still concerned, run your questions by a fiduciary accountant or financial advisor.
Conclusion
A stock market crash is scary. The last thing you want to do is look at your investment accounts.
And that’s okay.
Just keep moving forward, making your standard contributions. Add more if possible, you’re buying at a discount.
Even if you buy shares at $20 now and they continue to drop to $5, you will still own those shares. And you’ll be glad you own them when they go back up to $40 and you realize that you got in at 50% off.
Stay healthy and stay the course.
Related reading
Pay Yourself First – The #1 Wealth Building Secret
This is What Your Retirement Savings Needs to Be at Every Age
The 12 Financial Rules to Live By
