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Listen to the Podcast Here: 4. Expect the Market to Crash

We recorded this blog post as a YouTube video and podcast on May 5, 2022. As I’m editing this blog post on May 10, 2022, the stock market has gone through a roller coaster so far this year. Yesterday alone, the S&P 500 fell 3.20%, the Dow fell 1.99%, and the NASDAQ fell 4.29%. Year-to-date, the S&P is down 16.26%, the Dow is down 11.26%, and the NASDAQ is down 25.71%. Times like these are what lead many investors to make poor choices in trading their portfolios.

You Should Expect the Market to Crash

The S&P 500 Index is a stock market index that tracks the performance of about 500 of the top publicly traded US companies. While the S&P 500 Index isn’t a perfect gauge of the stock market as a whole since it only tracks about 500 companies in the United States, it’s the barometer that we speak about often and one that we will be referencing throughout this post.

Based on history, we should expect the stock market (the S&P 500 in this case) to decline sometime during the year by an average of 14% every year. Even though we should expect a large decline sometime intra-year, between 1980 and 2021 annual returns for the S&P were positive in 32 of those 42 years – that’s over 76% of the time.

To say this in another way with the intent of being clear, the S&P 500 could have a really big decline sometime within the year, but historically, the majority of the time it has ended positive despite that decline happening during the year.

A Recent Example From 2020

A really good example of this is what happened in 2020 when the S&P 500 dropped 34% from the February 19 high to March 23. Imagine (or not, if you were there for it) that 34% of whatever you had invested in the S&P was gone in a month. That can be really scary.

On March 16, 2020, the S&P 500 dropped 12% in one single day and the Dow and NASDAQ both dropped over 12% that same day.

Despite that, the S&P 500 ended the year positive 16.2%.

Fees vs. Fines

We really like the way that Morgan Housel writes about stock market volatility (AKA the big declines we just discussed). To start out his blog post titled Fees vs. Fines that was written April 2, 2019, he writes this:

“The last three months of 2018 was the worst quarter for stocks in seven years. However, the first three months of 2019 was the best quarter for stocks in 10 years.”

Housel then goes on to explain the concept of fees versus fines. He writes, “Fees are something you pay for admission to get something worthwhile in return. Fines are punishment for doing something wrong.”

We should think of declines in the stock market as fees, rather than fines. Your portfolio dropping due to the market dropping isn’t a fine, it’s a fee that has to be paid in order to obtain long-term gains.

Disneyland vs. The County Fair

In the same article, Housel compares stock market volatility, or as we’re describing it, market declines, to paying for tickets to Disneyland. People who go to Disneyland think that the fee of the ticket is worth paying because of the experience they receive.

It might be better if we think of stock market declines like this as well.

Sticking with the ideas in Housel’s article, you could take your kids to the county fair, and it would be much cheaper than going to Disneyland, but the experience would be different.

The stock market in this case is Disneyland and the county fair might be something like cash.

If you want higher returns, they don’t come free, and you have to be willing to pay the fee for them in terms of greater volatility and uncertainty.

Discipline = Freedom

It can be scary. It can be hard to see your portfolio losing so much money in the moment. There’s always been, and always will be, a different reason to think that you should get out of the market and go to cash and there always will be another ‘crisis of the day’.

“This time it’s different”, right?

There’s a slide from Dimensional Fund Advisors that they’ve titled Markets Have Rewarded Discipline which shows a bunch of reasons throughout history that people may have thought they should have gotten out of the market.

Here are just a few of them:

The COVID-19 pandemic, Brexit, the Eurozone debt crisis, the Great Recession, and the subprime mortgage crisis.

But historically, and we’ll give the disclaimer here that past performance isn’t indicative of future results, the market has continued to reach all-time highs despite all of these reasons that one may have thought that they should sell out of the market.

What Am I Supposed to do with This Information?

Hopefully we’ve done a pretty good job of letting you know that you shouldn’t necessarily freak out when you see your portfolio decline, but what should you do with this information?

First of all, it’s important understand and to implement the concept of diversification in your portfolio. We’ve spoken a little about diversification before, but it means have your money spread across different investments. This could include US large cap stocks, US small cap stocks, international stocks, emerging markets stocks, real estate, bonds, etc. (Please note that this is not an exhaustive list, rather a few examples.)

Additionally, it’s extremely important to consider your personal financial situation. Someone who is young and has a long time until they need to use the money might be able to have a riskier portfolio than someone who is older and might need to money sooner or someone who is already retired.

But, at the same time, we often hear people who are nearing or in retirement who are worried about stock market volatility. For those people, I think it’s important that they’re in an appropriate portfolio – and that might be one that isn’t 100% invested in stocks.

If you’re drawing funds from your portfolio to pay for your lifestyle, then you need a safer bucket to draw from than stocks which can be very volatile. It’s also important for retirees to consider their investment horizon…through retirement, not to retirement… Just because you’re at or nearing retirement doesn’t mean that you’re done investing your money – hopefully you’ve still got a long time to live.