3 Important Lessons We Can Learn From Past Market Declines
On October 28, 1929, a day commonly known as Black Monday, the Dow Jones Industrial Average began a nosedive that lasted until July 1932, when it closed at 41.22, an 89% decrease from its pre-crash high. This period of falling markets kicked off the Great Depression. The market didn’t fully recover to its pre-Black Monday highs until November 1954.
But it did eventually recover. Investors who remained invested in the market throughout the Great Depression were poised to experience a 168.7% return over the three subsequent years after the market bottomed out.
This scenario has repeated itself throughout history. Markets tend to recover, even in the face of seemingly insurmountable declines. The following chart highlights various market declines across multiple generations. It illustrates how remaining invested throughout periods of market volatility has the potential to pay off over time.
Wise investors understand the benefit of maintaining a long-term investment outlook and not getting spooked when volatility rears its angry head. Instead, they remain steadfast in their investment strategy, knowing that markets tend to recover over time.
What can these generational market declines teach us about investing? Following are three important lessons we can learn from past market declines and the rebounds that followed.
Lesson #1 – Trying to time the market often does more harm than good.
If it were possible to time the market, we would all be multi-millionaires. In reality, none of us know how markets will perform, and we certainly can’t predict future volatility. It’s important to keep in mind that the best days in the market are often concentrated around the worst days in the market. Selling out to avoid a potential drop means you may miss out on the full benefit of a recovery.
Consider the following chart, which illustrates the impact missing just a few days of market performance can have on your portfolio over time. This chart provides a powerful visual of the importance of staying the course with a strategic, diversified portfolio designed to weather market volatility across market cycles, including both periods of decline and periods of recovery.
Lesson #2 – It’s important to remain invested, but it’s also important to have cash on hand.
While wise investors understand the importance of maintaining a long-term investment outlook, they also understand the importance of having cash on hand. Staying the course with a strategic, diversified portfolio means not having to sell your investments at a loss to pay for your daily living expenses. That’s why it’s important to keep some cash in a liquid emergency fund, such as a savings account.
It’s wise to have at least three to six months’ worth of living expenses in your emergency savings to avoid tapping into your investments at inopportune times. During periods of declining markets, you can withdraw these assets to pay your bills or cover an unexpected expense, avoiding the need to sell investments at a loss. Selling stocks at the bottom of a market cycle makes it more difficult to recover, as you’ll have less money invested in the eventual market recovery.
Lesson #3 – Volatility can enhance long-term returns.
Of course, no one wants to watch their account balance drop by 20%. However, those who resist the urge to sell out at a loss are in the best position to benefit from a future recovery for several reasons:
- Losses aren’t locked in until you sell. When you sell, you realize losses and forfeit an opportunity for future gains.
- Remaining invested allows you to participate in future market rebounds. As long as you still own shares, you have the potential to regain some — or all — of your losses when the market turns around.
- When prices fall, you can purchase additional shares for less money. Down markets offer a great opportunity to purchase stocks at lower prices than normal, which can bolster your returns even more when the market turns around.
The key to success in a down market is to have an investment strategy in place to help manage volatility and put you in a better financial position once the markets start to rebound. Your wealth manager can help you implement an investment strategy that’s in line with your overall risk tolerance, investment time horizon and goals for the future. For more of my financial insights, check out my new book: Money, Simplified.
If you could use some help positioning your portfolio to withstand future market challenges, Creative Planning is here for you. Our experienced teams help clients make smart investment decisions throughout all phases of the market cycle. For help with your portfolio, please schedule a call.