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Did you know that it took the stock market 25 years to recover from the Great Depression? Or that the stock market (as measured by the Dow) made virtually no progress from it’s pre-Bear peak in 2000 until mid-2006? Pretty scary stuff, especially when you consider that the Dow just experienced its third consecutive triple digit loss, dragging it down to a five year low.
As bad as this all sounds, it’s important to keep in mind that the situation would be considerably better if you continued investing throughout the down periods. Indeed, by sticking to your guns and investing in a down market, your “new” money (invested during the downturn) will turn a profit by the time your “old” money makes it back to even. All you need is nerves of steel…
Investing through a down market
Don’t believe me? Check this out… Assume that you invested $10,000 in a mutual fund that cost $100/share. Further assume that you had horrible timing, and the market went south the very next day, resulting in a 50% decrease in share price over the next 18 months. Fortunately, things eventually started looking better, and your investment rebounded to $100/share over the following 18 months.
How would you have performed? Well… If you had:
- sat tight, then you’d be back to even money
- panicked and sold, you’d have locked in at least part of your loss
- bought through the downturn, you’d be ahead of the game
Just to make things a bit more concrete, let’s assume that the price dropped linearly to $50/share during the first 18 months, and then recovered linearly to $100/share over the next 18 months. Let’s further assume that you invested another $10k after one and two years. In other words, your timing wasn’t great, and you ended up buying in about 6 months before the bottom (on the way down), and again six months after the bottom (on the way back up).
How would things look after three years, when the market is finally back to even?
Running the numbers
Here’s a quick look at the numbers:
Original investment: $10,000 @ $100/share = 100 shares
Year one investment: $10,000 @ $66.50/share = 150.375 shares
Year two investment: $10,000 @ $66.50/share = 150.375 shares
Now, in year three, you’re sitting with 400.75 shares at $100/share. Guess what? That’s a total value of $40,075 even though the market has been flat overall, and you only invested $30,000. Calculating your internal rate of return over that three year period works out to an average annual return of 15.10%.
And yet… The market didn’t actually go anywhere. Not too shabby.
While the numbers above are somewhat contrived, and the specifics will vary with things like how far the market falls, how much you invest during the downturn, and how quickly it recovers, the larger point still stands. Regular, consistent investing pays dividends over the long run, even in the face of market turmoil.
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