Most stock market investors will find it nerve-racking to see their portfolios drop by 50% or more. But a large stock market crash is usually beneficial for our long term finances and we should welcome a bear market sooner rather than later or even not at all. 😀
How an early stock market crash creates more wealth
During a stock market correction, all the new money we invest will be used to purchase assets at cheaper levels. 🙂 These investments can have more time to compound and grow.
Even if we somehow could avoid a bear market for the next 30 years, [our] retirement wealth would likely be substantially better if we instead experienced an immediate bear market. ~Mark Hulbert
Most people my age will probably retire around 60 years old. That gives us about 30 more years to save for retirement. I found a chart below, courtesy of Mark Hulbert from MarketWatch that shows how the timing of a stock market crash affects the value of a retirement portfolio. It assumes a constant annual rate of return for 30 years, except a brief period where the stock market crashes similar to what happened in the 2007/2008 global financial crisis.
The red bar at the far left of the graph represents the portfolio’s value at the end of 30 years if a stock market crash happens right now in 2018. The far right is when it happens near the end of the 30 year period. In all cases plotted on the graph, the average annualized return for the 30 year period is the same, which is 5.9%. The only difference is when that market correction occurred along the way. 😉
As we can clearly see, our portfolio’s value 30 years from now will be highest ($4.3 million) if a downturn happens immediately, and lowest ($1.9 million) if it happens right before we retire. Wow! We will have $2.4 million more if a major bear market breaks out now, rather than later, even when the overall annualized investment return is the same. That’s a huge difference. 🙂
If the stock market faces no correction, and instead steadily gains 5.9% every year for the next 30 years then we will have $2.4 million at retirement, which is still $1.9 million lower than if there was an immediate stock market crash. A future without any bear market at all would result in less wealth than one in which there is an early bear market.
Most investors focus heavily on annual returns. But now we know that the timing of a market correction also has a major impact on our retirement nest eggs.
This is why young investors who are still saving for retirement should not be trying to get out at the top of the markets. Instead we should embrace the next big market crash with open arms. The good news is we’ve been in a bull market cycle for nearly a decade already. Business cycles always go up and down, so the next major bear market could be just around the corner. I can’t wait. 😀
A bear market is good for investors building up a portfolio. However, the opposite is true for the older generation. A stock market correction for people who just retired will significantly reduce their wealth if they have too much exposure to stock investments. That’s why it’s important to manage risk and asset allocation throughout life. 🙂
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Random Useless Fact
I don’t disagree with you but the interesting thing about you saying this is that you do leverage your money. You borrow to invest so I wouldn’t expect this logic from you.
If my stock portfolio falls 50% in the next year it would not be enough to trigger a margin call. I would continue to add more money into it. The graph in the post above still applies to me. 🙂
Using leverage can increase one’s investment risk but there’s different degrees of leverage. In my situation a major stock market correction happening earlier is still better than later for my retirement nest egg, since my debt is controlled. 🙂
The same logic can be applied to any investment strategy. For example real estate investors are better off if they face a housing downturn earlier in their careers than none at all. Using leverage increases the risk, but it still makes sense to buy a property with the help of a mortgage regardless of a bull or bear market at the time. Things will even out over the long run. Those who get into trouble tend to be overly leveraged like buying a home they can’t afford or making a tiny down payment.
I disagree with your assessment too. Buying on the dip is good … but waiting for one is bad. Back in 2012 S&P 500 hit 1,450 pts. That was all time high back then. I waited on the sidelines looking for the next crash. I missed out on a solid 30% returns that year. Like you mentioned as long as you have a solid asset allocation taking into account risk factors … there should be nothing to worry. Timing the market is a losing game and is not sustainable in the long run.
I agree. Time in the market is better than timing the market. I know a guy in California who sold nearly all his stocks in early 2013 when stocks gained 11% in a few months. He said even if stocks go higher he would be happy making 11% for that year. But he missed out on the remaining 15%. That’s why I like to stay invested and continue putting new money into the markets. Don’t wait for a correction to invest what you have.
Very sobering, ironic and thought provoking at the same time. It makes sense, but it’s just so counter intuitive to wish for a bear market in the near term. It’s just no fun to go through it. Tom
I don’t really want to go thru one…. but I’m a math guy… I know how the numbers work out when we go thru one and I and I say on this course… I’ll be retired in 7 years versus 15 with over $3M. I’d rather start seeing this bear market or a crash..
I think being able to look at things not as they are now, but as a complete timeline laid out from start to beginning helps me to better accept the fact that a recession in the near term is a good thing. It’s not always easy to have a long term perspective but that’s why it’s so advantageous to do so. 🙂 Since there are fewer people willing to play the long game there is less competition in that space, compared to those who are trying to beat the market this year, or trying to not lose any money in the short term.
I look at a correction in another way as I am now retired.
IF I have enough dividends in my RIF to support a 5% mandatory(at 70yrs) withdrawal (so much for that infamous 4% withdrawal rate)then a reduction in the portfolio value will enable me to decrease the withdrawals and so have some money left to reinvest as long as I do not require the funds for living expenses. This would enable me to build the portfolio up to higher dividend levels or continue with the larger withdrawal and contribute to the TFSA.
Presently 100% equities and will now start to build a GIC (short tram) ladder to cover the market variations. After all, the government wants their deferred taxes back and will grind the RIF down to “0” so I need to cover the possible lower stock values so as to not sell at a low.
RICARDO
Yes, the strategy becomes different for retirees. That is one transition I’ll probably be making over the next decade. The 5% mandatory withdrawal rule kind of sucks. I don’t like it when the government forces people to do certain things with their own money. But I understand why this rule is in place.
DUCK HUNT!!!
Good luck with your retirement plan. It sounds like you’re a millionaire already so you know what you’re doing. 🙂
Haha Duck Hunt! I just had the theme song for that game go through my head, classic Pavlov’s response from many hours playing that game as a kid.
I do DCA and buy on the dips. I wish I had more cash to invest though I have more cash than I did in 2008.
Cash always comes in handy when the market dips like it’s doing lately lol.
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