Market drawdowns are never fun and seem inescapably uncomfortable. However, the shares you buy during market drawdowns, corrections, and/or bear markets are often the best purchases you will make. Here is some perspective on investing amid downturns, with a real-world comparison of two investors.
What should you do when the market corrects?
“Don’t do something, stand there!”
– John Bogle, Founder of The Vanguard Group
“Remain disciplined and stick to the plan” must be among the least satisfying answers perennially provided by financial advisors, but that doesn’t make it wrong. Good investing is simple, not easy.
Investment markets are unique in that buyers are generally less interested to buy when prices are cheap. Instead of eagerness to jump in at the lowest prices seen in several years, each time the market falls by 10%, 20%, or more, investors hesitate and begin thinking “this time is different.”
This time very likely is different, but also very likely should not deter you from your investment policy. Your investment policy is a well-researched strategy that you put together through an analysis of facts, risk tolerance, time horizon, and liquidity needs, instead of emotion. Far easier said than done, but try to remind yourself of the mindset you were in when creating your investment policy compared to the emotional mindset you may have during a correction.
Staying the course and remaining disciplined continues to be the best advice I have to offer amid these downturns.
- Check your investment allocations and rebalance if things have strayed from your stated objectives
- Continue dollar-cost-averaging into your investment portfolios, taking this opportunity to buy beaten down assets
- Avoid the temptation to make a drastic change and time the market
If you’re decades from retirement and regularly investing for this far-off goal, you could even begin to recognize the opportunity presented by these market corrections by keeping the following example in mind.
A Tale of Two Investors
Let’s examine the case of two investors who both invest $100,000 over ten years in the same fund, but in different time periods. These investors purchase $10,000 per year of an S&P 500 Index Fund (a common benchmark for the U.S. stock market) for a decade straight, then stop making additional purchases but keep their money invested over the following decade. Investor 1 begins in 1990 and Investor 2 begins in 2000.
First Decade’s Results
Investor 1 invests during a great time for the stock market. During the 1990s, the S&P 500 gains an annualized 18% per year. Investor 1 invests a total of $100,000, but their portfolio is worth over $332,000 as the 1990s come to a close.
Investor 2 finds themselves in a far more challenging decade for stocks. In the first decade of the new millennium, the S&P 500 suffers two major declines, the Dotcom bubble and Global Financial Crisis, and declines an annualized 1.0% per year. However, because Investor 2 was disciplined and invested $10,000 each year, even during major drawdowns, the ending portfolio value after this decade is slightly more than the $100,000 invested, ending 2009 at $104,830.
Second Decade’s Results
During the second decade, both investors cease adding to their portfolios but remain invested in their S&P 500 Index Fund.
Investor 1 saw incredible gains during the 1990s but is forced to watch their $332,000 fall to just under $300,000 during the first decade of the 2000s. Investor 2 weathered a challenging first decade of their investment, but the S&P 500 gains an annualized 13% from 2010 through 2019 and Investor 2’s portfolio grows from $104,830 at the end of 2009 to $368,699 after 2019.
Examining the Full 20 Years
Despite the same dollars invested over one decade, the timing of those investments led to dramatically different results for Investors 1 and 2. Investor 2 ended their 20-year period with over $69,000, or 23%, more than Investor 1.
This real-world example demonstrates the value of continuing to buy and staying disciplined during market downturns and poor-performing years (or decades). Counterintuitively, investors with a 20+ year time horizon could even hope for a market like the first decade of the 2000s. This would allow the investor to make many purchases at cheap prices instead of buying at higher and higher prices during a bull market run.
And one more surprising fact about this example: Investor 1’s time period from 1990-2009 saw much greater annualized returns for the stock market than Investor 2’s time period of 2000-2019, 8.1% vs. 5.9%. However, as we have already seen (and unfortunately for Investor 1), these gains came in the first decade when Investor 1 was still putting money into the market. Investor 2 was able to make all of their purchases during a down period and see their investment benefit from the subsequent decade’s bull market growth.
A Mindset for This Correction and Those to Come
To reiterate, market downturns are never fun and seem inescapably uncomfortable. No matter how much financial data you consume and market history you read, seeing your own portfolio decline during these periods of market turmoil can be gut-wrenching. However, hopefully by reflecting upon history, assessing your time horizon, and maybe even reviewing the buys you made into your 401(k) during the last several market corrections, you can more easily stay the course during this correction and many more to come.