This post is from staff writer William Cowie.
I don’t know about you, but talk around the dinner table touched on last week’s drop in the stock market more than once this past weekend. The stock market makes headlines for only one of two reasons: it reached a new high, or it fell. But no matter which headline it makes, the reaction is always the same: “Are we preparing for the the Big Drop?”
“They” say those who don’t learn from history are doomed to repeat it. So, let’s take a look and see if there’s anything we can learn from the history of drops like these. Here’s a snapshot of the stock market as of this past weekend.
Stock market June 2012 – June 2013
The question, as always, is: well, what’s next? Isn’t this what the market looks like before it drops? Should we brace ourselves?
Let’s ask the same question of this chart:
Stock market example 1
Look at the two charts. Isn’t the resemblance uncanny? The same pattern of growth before a big dip and a small recovery. Over dinner the night this happened, people might have wondered: what does the future hold? There are two possibilities:
- This is just another blip on the way up. As you can see from any chart, the market doesn’t go up (or down) in a straight line. There are always wiggles and jiggles, which in time give way to a larger trend.
- The second possibility is the dip is the prelude to The Next Big Drop.
The second chart covers the period from October 21, 1996 to October 16, 2000. What happened back then?
Stock market 10/21/96 – 9/30/02
Oops. That dip, the one with the uncanny resemblance to the one we saw last week, was the prelude to the bursting of the dot-com bubble. Scary, huh? Is this a lesson from history we have to learn from or be doomed to repeat it? Or could it be something else? Let’s look at another example.
Stock market example 2
Once again, a similar pattern: a bumpy rise, leading to a drop and small correction. Again, dinner conversation that night probably included a discussion wondering whether that dip was a blip, or the prelude to The Drop. That time, though, the dip did not lead to a Big Drop. The date was April, 2004, and here’s what happened afterward:
Stock market 3/11/03 – 7/9/07
Rather than a Big Drop, the market grew by another 37 percent over the next four years.
You can cite history (example 1) as support for making the case that last week’s drop signals the next Big Drop. (There is always a “Next Big Drop,” because the stock market, like the economy, moves in waves). However, you can also cite almost identical evidence from the past (example 2) to argue that this was just another in a long series of dips on the way to new market highs. The fact is, we don’t know what the future holds.Nobody does. Anybody who wants to tell you otherwise is disingenuous at best, and, at worst, trying to sell you something you should not be buying.
What do you do?
If you’re like most responsible people, you have a 401(k) plan at work, an IRA, or some other investments. With those investments, you cover all but three or four types of investment open to individuals. (Those exceptions would be a rental home, precious metals or crowdfunding loans.) Part of your investments, therefore, probably are tied to the stock market in one way or another. So, what do you do in reaction to a market drop like we had last week?
More than 10 years
If you’re more than ten years from retirement, you know that even if the market drops, it comes back again, and the time lapse between peaks is roughly seven to ten years. Doubt that? Judge for yourself:
Stock market 1990 – Present
You can see: the stock market peaked in 1990, 2000 and 2008, spans of 10 and 8 years, respectively, repeating a pattern over many decades (and even centuries). What that means is even if the market drops, it doesn’t matter to you if your time horizon is more than ten years. The market always comes back, sometimes to the same level but most often to greater heights. You have nothing to worry about, then, even if last week’s dip presages the next Big Drop.
Less than 10 years
But what if you retire in the next ten years? Even then, you’re still largely unaffected. Whoa… isn’t that a little radical? How can I say that? Well, think about it: do you know anybody who, on the day they retired, called up their broker and sold every single share of stock they owned? I doubt it. And, even if they did, what would they do with all that cash? Makes no sense. What happens most frequently is people stop earning a paycheck from a job, and begin to collect checks from their retirement fund. And those checks come from stock dividends or bond interest (or a combination of both). And the cash from dividends or bond interest are unaffected by stock market prices, aren’t they? You own what you own, and they pay what they pay. And what they pay has nothing to do with what they sell for on the open market.
Therefore, what you need to do if you plan to retire in the next ten years is gradually shift your assets into ones that will throw off the cash you plan to live on: dividend stocks, bonds or rental properties. The good news is you can do that whether the market is up, down or sideways. Why? Because even if you lose your shirt on the stock you sell, you get that shirt right back on the stock you buy with the proceeds — because the parties selling that stock lost their shirts on it. Most stocks move in sync with one another, so if your stock fell, the one you’re buying also fell. Trading one low-priced stock for another low-priced stock is the same as trading one high-priced stock for another high-priced one.
So, again, it doesn’t matter whether prices are high or low. If you plan to live off dividends, a rise or drop in stock prices won’t affect you, especially if you own one or more dividend aristocrats (companies who have increased their dividends more than 25 years in a row). This is shocking to most people. It sounds so wrong. However, if you look at it in the cold light of day and disregard the sensationalist rhetoric the media lives off, stock prices don’t matter to you all that much. Unless, of course, you’re totally starved for something to talk about over dinner.
Credit: all charts courtesy of Yahoo Finance (Symbol ^GSPC — S&P 500 stock index)