Thursday, 26 December 2019

What To Do When The Stock Market Crashes


What should you do when the stock market crashes? Stock market crashes can be some of the hardest times to be an investor especially if you're just starting out. If you haven't been investing for very long it can be pretty scary seeing your investments go down by 20%, 30%, 40%, or even over 50% in the span of just a few short months. Today we are going to see how long it takes an individual's net worth to recover from various stock market crashes using the S&P 500 as an example. I'm going to be looking at scenarios where the individual was investing one year prior to the crash as well as 5 years 10 years and 20 years prior to the fall and show how even though it might take the stock market say 7 or so years to recover from a crash like he did during the dot-com bubble, it doesn't necessarily take that long for the individual to recover from that same crash assuming they keep investing. 

I'm only going to be looking at 3 major stock market crashes. The crashes I'm going to be looking are


  1. Crashes Of The 1970s
  2. Dot-Com Bubble Crashes
  3. Housing Crisis

I choose these 3 crashes specifically because the max drop from the market's peak all the way down to low point during the crash was over 45% in all cases, so statistically anyway, these are among the worst in the stock market history. 


Let Get Started


1. Crashes Of The 1970s

The crash of the 1970s began in December 0f 1972 when the S&P 500 reached a peak of $118.05 before dropping to a low of $63.54 in September of 1974. That was a total drop of about 46.2% and it would take the market nearly another 6 years to fully recover and set a new record high of $121.67 in July of 1980. In total, this market cycle lasted for about 91 months, or 7 years and 7 months but how much of a difference could an individual make if they continued investing during the crisis?


  • Net Worths: 5.25%, 3.75%
  • Before Crash: $6,461, $37,300, $80,555, $245,540
  • During Crash: $10,800, $27,000, $50,370, $139,174
  • Drop: 15%, 31%, 37%, 43%
  • Months To Personal Recovery: 4, 18, 30, 48
  • At Market Recovery: $64,825, $96,000, $140,596, $310,641

Let's take John, for example, he starts investing $500 a month and decide that he will continue investing that $500 a month regardless of what the market does. If he began investing in December of 1971 or one year before the start of the crash. By the end of his first year of investing due to the market slowly creeping up, he would have a net worth of $6,461.87. That's of course when the market begins to tank. However, John doesn't really notice this, not because he's not paying any attention to what the market is doing, because he is even though he's not going to let it affect his decision to invest, but because of his net worth is actually by large still going up. At the end of his second year of investing he has a net worth of $10,649.71. This trend continues for another 7 months where John reaches what was then an all-time high net worth for him of $12,803.65.

At that point, the market continue drops finally catch up with John and his net worth over the next 3 months drops from over $12,800 to $10,800, or about a 15% drop from his personal net worth. Now losing $2,000 off your net worth over the course of 3 months is not necessarily an idea of the situation but considering that the S&P 500 at this point as lose 46.2% since this start of the crash and John's net worth has gone up since the start of the crash from almost $6,500 to $10,800 he's not doing all that bad. In fact, he's up about 67% as an individual despite the crash. He'd certainly be up even more if the market had continued to grow, but considering the circumstance and the fact that it only took 4 months to recover his original net worth high of $12,8000, he's doing alright. And of course, as it always does, the market itself eventually recovers and John's net worth continues growing, but now at an even faster pace. 


  • By the time the market fully recovers in July of 1980, about 8.5 years after John began investing he has a net worth of $64,825. This means that in just 8 years and 7 months that he's been investing, John's average rate of return has been about 5.25% which doesn't sound that great, I understand, but keep in mind that is his rate of return during a major market crash.

We haven't taken into account any bull market that may have come afterward. We just had him start investing a year before the crash ( so he was basically buying at nearly the high) until the market got back to where it was before the start of the crash. That's it. And he's till manage 5.25% during that time. And of course, during that same span, the market gains very little, if anything, while John only sees a temporary 15% drop in his investments which disappears completely in 4 months and as I said, still earn over 5% a year.

Those are the things to keep in mind here. But while it is nice to know that we as an individual are less likely to feel the brunt of a market crash if we haven't been investing for very long obviously the numbers do change a bit if we have been investing for a while.


  • Net Worths: 5.25%, 3.75%
  • Before Crash: $6,461, $37,300, $80,555, $245,540
  • During Crash: $10,800, $27,000, $50,370, $139,174
  • Drop: 15%, 31%, 37%, 43%
  • Months To Personal Recovery: 4, 18, 30, 48
  • At Market Recovery: $64,825, $96,000, $140,596, $310,641

Let's say John had been investing for 5 full years before the start of the crash. What would the numbers look like then? Well, we would see that John has a $37,300 net worth when the market hit its peak, which actually ends up rising to about $39,200 due to the fact that the market didn't drop like a rock right away in this particular crash. However, when the bottom really did fall out of the market his investment's net worth dropped from about $39,200 net worth down to just over $27,000 in 11 months. It was a 31% drop and John wouldn't personally recover from it for 7 months. Meaning that the cycle starting from when the market reached its peak to when John himself recovered took about 18 months or about a year-and-a-half to complete. When the market fully recovered in July of 1980 John's net worth was just over $96,000. So, again during that time span, the market gains very little, and John's sees a temporary 31% drop in his investments, which is big don't get me wrong but not nearly as big as the 46% drop the market experienced, and it disappears completely in 7 months and he still earns 3.75% per year during one of the worst crashes in the stock market's history.

Of course, that's not counting the bull market that followed this crash which saw that S&P 500 reach a value of about $330 per share, which is over 2.5x the value of the market in 1980, before the flash crash of 1987, which lasted less than 2 years. Anyway, the percentages weren't as good as in the previous example where John only started investing 1-year before the start of the crash but that kind of makes sense, right? Let's say if you had been investing $1,000 per year and buying 10 shares of stock that were worth $100 per share for 20 years... You would have 200 shares and those 200 shares would be worth $20,000. Then if the market crashes and your investments go down by 50% the next year you would still invest your $1,000 but this time you would buy 20 shares of the stock since it is now worth $50 a share after the crash, and your net worth at the end of the year would be $11,000. 


  • Shares Owned: 200
  • Price Before Crash: $100/Share
  • Value Before Crash: $20,000 (200*$100)
  • Price After Crash: $50/Share
  • Value After Crash: $10,000 (200*$50)
  • Annual Amount Invested: $1,000
  • New Shares Purchased: 20 ($1,000/$50)
  • New Shares Owned: 220 (200*20)
  • End Net Worth: $11,00 (220*$50)

Meaning that your net worth is down by 45%. However, if you had been investing the same $1,000 per year into the same $100 stock but for only one year, you would have 10 shares before the start of the crash and those shares would be worth $1,000. Then if the market again drops 50% and you invest your $1,000 in year 2 and buy 20 shares at $50 per share that would give you a total of 30 shares worth $50 each or a net worth of $1,500.


  • Shares Owned: 10
  • Price Before Crash: $100/Share
  • Value Before Crash: $1,000 (10*$100)
  • Price After Crash: $50/Share
  • Value After Crash: $500 (10*$50)
  • Annaul Amount Invested: $1,000
  • New Share Purchased: 20 ($1,000/$50)
  • New Shares Owned: 30 (10*20)
  • End Net Worth: $1,500 (30*$50)

So in that scenario, you're up about 50% over the cause of the year, despite the fact that the market crash because you're buying low while the investment is effectively on sale and because the amount you're investing, in this cases, $1,000 per year, is still a sizeable percentage of your net worth. 


  • Net Worth: 5.25%, 3.75% 
  • Before Crash: $6,461, $37,300, $80,555, $245,540
  • During Crash: $10,800, $27,000, $50,370, $139,174
  • Drop: 15%, 31%, 37%, 43%
  • Months To Personal Recovery: 4, 18, 30, 48
  • At Market Recovery: $64,825, $96,000, $140,596

And we see this mathematical phenomenon play out in each scenario, with the largest percentage drops in John's personal net worth getting closer and closer to what the market actually drop, as he's been investing longer and longer, but he never quite getting there because he's recovering some of his losses by buying more share when the market is low and the amount of time he takes for him to recover his personal net worth is also getting longer and longer, but again never actually becoming quite as long as it takes for the market to recover. In fact, in the crash of the 1970s even when John had been investing for 24 years before the crash started, he still only takes 48 months or 4 years to recover his personal net worth compared to the 7 years and 7 months that took the market to recover. And we see this pattern continue into the Dot-com crash.

2. Dot-Com Bubble Crashes

The Dot-com crash began in August of 2000 when the S&P 5000 reached a peak of $1,515.68. After a phenomenal run through the 1990s before dropping to a low of $815.28 in September of 2002. 
That was a total drop of about 46.3% and it would take the market another 5 years to fully recover and set a new record high of $1,530.62 in May of 2007, not that it ended up lasting long as we now know. In total, this market cycle lasted for 81 months or about 6 years and 9 months but the numbers for John look fairly similar, if not a little better than they did during the crash of the 1970s.


  • Net Worths:
  • Before Crash: $7,000, $49,927, $157,862, $644, 603
  • During Crash: $12,745, $35,804, $93,785, $355,257
  • Drop: 11%, 28%, 41%, 45%
  • Months To Personal Recovery: 7, 36, 59, 76, 
  • At Market Recovery: $63,253, $106,438, $215,017, $704,398

As you can see the months that it takes to recover his personal net worth are a little larger than they would during the crash in the 1970s, and that in part because the Dot-com crash took quite a bit longer for the market to fully reach its low point than it did in the 1970s, but compared to the crash of the 1970's it was a much slower climb back to the top of the market. After reaching the bottom. For instance, once the market got to the point where it loses 40% of its value, it took 9 full months to get back below that 40% loss mark and another 7 months to get past the 30% loss mark. The point I'm trying to make here is that once we got to the low point of the market during the Dot-com crash, we stayed close to it for a long time! But what that means is that we as an investor had many opportunities to buy our favor investments when they were on a huge sale and that's why you see such a big difference in the net worth figures at the point when the market recovers during this crash compared to the crash of the 1970s and also as you can see below now the housing crisis.


3. Housing Crisis

The housing crisis or the great recession began in October of 2007 when the S&P 500 reached a peak of $1,549.38 before dropping to a low of $735.09 in February of 2009. That was a total drop of about 52.6% and it would take the market another 4 years and 1 month to fully recover and set a new record high of $1,569.19 in March of 2013, which has been the bull market that we have basically been riding ever since.



  • Net Worths:
  • Before Crash: $6,905, $40,471, $79,889, $307,416
  • During Crash: $8,443, $24,368, $43,070, $151,018
  • Drop: 19%, 46%, 51%
  • Month To Personal Recovery: 8, 25, 36, 53
  • At Market Recovery: $50,156, $84,151, $124,073, $354,510

In total, this market cycle lasted for about 5 years and 5 months and as it turns out, it performed much like the crash of the 1970s when it comes to the number, just obviously with a bigger drop from the top of the market to the bottom of the market and a shorter cycle of recovery. But as a result, the numbers look similar.


What You Can Do:

We've already covered how most market crashes don't last more than a few years, but as we see now, even the ones that do can be managed to a certain degree, by just staying the course and continuing to invest. This is especially true if you've only recently started to invest, and even more true if you've just now started to invest. You have to remember that even in the bad times we can do fairly well. After all, as I said, when the stock market crashes it's like we're buying everything in it on sale, and when the time comes those sale and net worths are going to skyrocket. 


Conclusion

From an investing perspective, stock market crashes are not bad things. And don't ever let the fear of one happening keep you from investing in the first place. The worst thing that could happen to you during a stock market crash is losing your job and not being able to get another one. And if that's something that worries you, I know, believe me, I've been there, then there are a few things that you can do. 


  1. Build Up Your Emergency Fund
  2. Invest More Into The Market During the Crashes While You Still Can
  3. Diversify Your Income Streams.




That's the takeaway I want you to get from this. And I hope you got something from this article.

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