One of the important parts to the personal finance conversation is centred on when someone should start investing. When it comes to timing, one of the biggest concerns that comes up in conversation is the risk/fear of the market crashing. Generally, markets move in an upward direction, however there are certainly times when the bears take over and asset prices fall by 20%, 30%, 40% or even more. Further to this once the market has bottomed out, it can sometimes take years for the market to surpass its previous peak. The fear of losing 40% of your capital can be a really scary thought. It is this fear of loss which causes people to sit on the sidelines waiting for an opportunity. In turn this causes them to miss out on much of the gains that the market will present.
Generally you have to be pretty unlucky to start your investing journey at the absolute top of the market and understandably this is where some of the fear comes into play – what if I started investing now and the market crashes tomorrow? So what I’ve decided to do is to introduce you my made up friend Bad Luck Bill. Bill is on a quest for financial independence but because he has such bad luck, all of his 4 journeys will start at the peak of the market. Here’s Bill’s investing strategy:
- Bill will be investing in the S&P 500 index only (valuations include reinvested distributions)
- Bill will invest $3000 per month every month for periods of 10, 15 and 20 years
- Bill will start investing the month before 4 of the most recent bear markets. In each of these cases the S&P 500 index will fall at least 20% as measured from peak to trough
- Bill will stop investing after the 10,15 and 20 year periods are up
Alright! Let’s talk about the bear markets:
Bear Market 1980
In 1980 the US Federal Reserve decided to raise interest rates to nearly 20% in order to combat sustained inflation. This caused a recession in the US and saw the S&P 500 to lose 27.8% of its value over a course of 21 months (NBC News 2019).
Stock Market Crash 1987
If you think waking up for work on Mondays is bad, how about a Monday where you lose 22% of your portfolio value! Yep, I’m talking about October 22, 1987, the infamous Black Monday (Kenton 2019). Based on month end pricing, from its peak of 329 points the S&P 500 would fall to 230 points (a loss of 30%) and not recover until July 1989 (Yahoo finance 2019).
Dot Com Bust 2000
The 1990’s was the time of the internet and an abundance of venture capital funding for internet start-ups (Hayes 2019). The S&P 500 reached a peak of 1517 points in August 2000 and worked its way down to 815 points in September 2002 which is a loss of 46%, I guess throwing in a the terrorist attacks in 2001 didn’t really help recovery either. It would be close to 5 years after the trough before the S and P 500 would surpass its previous peak in May 2007 (Yahoo finance 2019).
Global Financial Crisis 2007
This one might still be fresh in your minds. From peak to trough took a little under 2 years with an eventual loss of 52%. It would then be over 3.75 years before the S&P 500 recovered to its previous peak. (Yahoo finance 2019).
The spreasheets are done and the numbers are crunched! So let’s see how Bill has fared after 10, 15 and 20 years
Starting prior to the bear market of 1980
| 10 years | 15 years | 20 years | |
| Total invested | $360,000 | $540,000 | $720,000 |
| Portfolio value | $571,913 | $1,334,345 | $3,545,772 |
| Return p.a. | 9.19% | 11.34% | 14.16% |
Starting prior to the stock market crash of 1987
| 10 years | 15 years | 20 years | |
| Total invested | $360,000 | $540,000 | $720,000 |
| Portfolio value | $852,218 | $952,837 | $1,750,626 |
| Return p.a. | 16.74% | 7.29% | 8.23% |
Starting prior to the Dot Com Bust of 2000
| 10 years | 15 years | 19 years 2 months* | |
| Total invested | $360,000 | $540,000 | $690,000* |
| Portfolio value | $349,041 | $914,132 | $1,433,821 |
| Return p.a. | -0.45% | 6.78% | 7.17% |
Starting prior to the GFC of 2007
| 10 years | 12 years* | – | |
| Total invested | $360,000 | $432,000* | – |
| Portfolio value | $623,297 | $789,983 | – |
| Return p.a. | 10.83% | 9.78% | – |
The above results present some interesting facts. The first of which is the that the only sample period in this study that has presented negative portfolio growth has been when Bill started investing in August 2000 before the Dot Com Bubble burst and stopped investing after a period of 10 years. This is partly due to the fact that 10 years after the Dot Com Bubble burst the market was only beginning to recover from the GFC. Starting at this time also resulted in the lowest 15 and 19 year compound growth. This is likely in part due to how hard the S&P 500 rallied during the 1990’s.
Of the 4 bear markets examined in this study the GFC was the deepest and longest lasting. Even so sticking to a regimented investing has rewarded Bill handsomely over 10 and 12 years periods.
Concluding thoughts
This is the section where I need to reiterate the fact that Bill started each of his investing journeys at the absolute peak of the market and psychologically there is almost no worse time to start an investing journey. Looking at the results that Bad Luck Bill has obtained through his consistent strategy are actually quite impressive and should alleviate some concerns held by those that may be fearful of starting their investing journey before a bear market.
One key finding from this study is that investing consistently is an excellent defence against unpredictable falling markets. This method, commonly referred to as dollar cost averaging, allows investors to purchase fewer units at a high price and conversely purchase more units at lower prices. It also happens to be the method that is applicable to most people since it aligns well with receiving a periodic pay check.
So the key takeaways from this study are:
- Investing in a diversified asset that approximates the S&P 500 index consistently will protect you from sudden bear markets while exposing you to the generally more prevalent market upside
- If your fear of markets crashing or losing value is stopping you from starting your investing journey, then find comfort in the fact that your luck is probably not going to be as bad a Bill’s so following the same strategy will likely result in higher returns.
Engineer your freedom
*Insufficient time has passed to accumulate data for the full investment period
References
Kenton, W, 2019, Stock Market Crash of 1987, Investopedia, viewed 14/12/2019, <https://www.investopedia.com/terms/s/stock-market-crash-1987.asp>
Hayes, A, 2019, Dotcom Bubble, Investopedia, viewed 14/12/2019, <https://www.investopedia.com/terms/d/dotcom-bubble.asp>
NBC News, 2019, 11 Historic Bear Markets, last accessed 17/12/2019, <http://www.nbcnews.com/id/37740147/ns/business-stocks_and_economy/t/historic-bear-markets/>
Yahoo finance, 2019, S&P 500 (^GSPC), last accessed 16/8/2019, <https://finance.yahoo.com/quote/%5EGSPC/history?period1=-631180800&period2=1565884800&interval=1mo&filter=history&frequency=1mo>