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What should you do during a market crash with your investments? This is a very common question that comes up around the world whenever the markets show a significant drop. So-called finance experts love this time, because they get a lot of facetime on TV and give a ton of different advice. Here is an analysis of historical market recoveries for major market crashes.
The asset management company Fidelity performed an internal study of the performance of their clients for the time period from 2003 to 2013. The most successful group of investors were dead people and those who had forgotten their investments.
Playing dead, meaning you do not touch your investments at all, is quite hard in times of crisis. Seeing your total net worth drop 40% and more is an emotional roller coaster.
Therefore, in this post I want to find out how long a dead person (or a person not touching their investments) would historically have to wait for their investments to reach pre-crisis levels.
First, I am only interested in the worst stock market crashes in modern day history. Meaning, any major stock market crash since 1927.
I got a list of the major stock market crashes from Wikipediaand focused only on those with an effect on the US. Why just the US? Because the US is the largest economy in the world and has an effect on the global economy and other stock exchanges.
If you have a diversified portfolio, then anything which impacts the US, will also impact your performance in other regions of the world.
Second, I used the S&P 500 as the benchmark for market performance. Again, it represents roughly 80% of the US stock market and daily data is available from Yahoo Financesince 1927. This means that I am assuming that we have a portfolio of 100% stocks and all of it invested in an S&P 500 index fund.
Lastly, I am interested in the absolute worst case scenarios. Meaning, I want to know:
- How much did the market fall from the absolute high of the S&P 500 before the crisis, to the absolute low? And how long did it take to reach that low?
- How long did it take for the S&P 500 to get back to that high level pre-crisis?
- How long did it take for the S&P 500 to get to double the pre-crisis level?
This way we can look at the absolute worst case scenario. Most people will not have invested at the absolute high and many will have continued investing through the crisis and after the crisis. This means that they would have recovered their money much faster in any case.
The first thing that is apparent is that there was one monster event in the last 100 years. Namely, the Great Depression combined with The Wall Street Crash of 1929.
The drop was 86.2% and it took a full 25 years to fully recover from that shock. The other stock market crashes look like small mini-crashes in comparison. The good thing is: it did recover! And it only took an additional six years for it to double.
In three of the stock crashes it would have taken less than a year for your investment to have fully recovered, for another two crashes it would have taken an additional year.
What do we learn from the table above? Playing dead makes sense.
First, drops during market crashes can be enormous. Make sure you are mentally prepared to see between two and four major market crashes of 35% more drops during your investing life-time.
This does not mean that you need to change your investing strategy, but make sure that you are mentally prepared for it to happen. Just accept that they will come and that is ok for them to do so.
Second, recovery periods are remarkably short. Do not panic! During the financial crisis of 2008 your investment would have dropped by nearly 57%.
Honestly, I would not have been able to sleep peacefully at night seeing my net worth drop that low within 1.4 years. However, it took only three years to full recover and another six years to double my pre-crisis investment.
Market Crash Recoveries with Investing
The exercise we did above was under the assumption that you would simply “play dead” and not invest any further money during and after the market crashed. Let’s extend the sample by assuming that you were one of the people who managed to keep a job during all crisis and generate income. Is this a bad assumption?
During the great depression the unemployment rateclimbed to a high of 24.9% in 1933 and was at a maximum of 10% during the financial crisis of 2008. This means that even during the worst financial crises, at least 75% of America had a job.
The highest unemployment rate recorded in Europe was in February 2013 when it reached a peak of 11.5%.
Therefore making the general assumption that someone was able to keep their job during a financial crisis is not too far off.
Now I do not only want to make the assumption that you were able to keep your job, but also that you were able to save and invest some of your income. Let us see how fast we are at the initial level of our net worth if we are able to save different levels of money every month.
Looking at these results there are three main conclusions I draw from it:
1) Saving just a small percentage (<0.5%) of your net worth every month during a crash, does not help your recovery time that much. Anything beyond that will shorten your time quite considerably in most cases.
2) If you just started the process of building your net worth and a major stock market crash hits, you should be celebrating. If your net worth is low, it is much easier to save a high percentage of your net worth than if your net worth is quite considerable.
For example, if your net worth is CHF 50’000, it is much easier to save 2% of it every month (= CHF 1’000). If your net worth is CHF 1’000’000, then saving 2% (= CHF 20’000) every month is very difficult, if not nearly impossible.
This means that a) you will be able to get back to your initial net worth much faster and b) that you will be able to accelerate the growing of your net worth much faster than someone who takes more time to recover.
3) The bigger the market crash, the more effective a high savings rate is. For “small market crashes” of 16% to 33%, having a high savings rate will not help you recover that fast. For market crashes of 40% and above, a high savings rate has a huge impact on getting back to your initial net worth much faster.
Playing dead during a market crash is a good strategy. Historically, your investment has always recovered quite fast (except for the Great Depression). It is important to understand that you will face such a market crash two to four times during your investing career.
Make sure that you are mentally prepared for it and will not freak out if something like that happens. Just play dead.
The most potent combination from a financial point of view is if you can combine a market crash with a high savings rate post-crash. This means you will not only be able to recover faster, but give your net worth accumulation a huge boost.
If a market crash hits and you are young, celebrate. If a market crash hits and you are towards the end of your investing career, try to reduce your expenses and simply play dead. Or consider going back to work for a limited time period.
- Discuss the recovery time periods with your significant other (or parents, friends, siblings).
- Write down on a piece of paper or your personal investor policy that you will play dead when a crash hits.
- Make sure you are mentally prepared that market crashes will hit you two to four times in your investing life.
What are your thoughts on the timelines of the historical market recoveries? What are you surprised about and what was exactly as you expected it to be?
Let me know in the comments or send me an e-mail at firstname.lastname@example.org. Any questions, concerns, feedback and constructive criticism is highly appreciated.