In this article, I want to touch on some key facts about the markets to help you stay the course. But, before I do that, if you want a complete understanding on the influence of investor behavior on market returns I recommend reading unshakable by Tony Robins.
Okay with that said let us talk about when stock markets drop i.e. “winter”-my favorite season. So how often does winter happen in the stock market?
Since 1900 there has been on average a correction every year or about 119 corrections. A correction is drop in the stock market of 10% or more. On average, a correction lasts 54 days. That being said 20% of those corrections turn into bear markets. A bear market is a drop in the stock market of 20% or more. On average a bear market will last 1 year with the longest being 694 days* and shortest being 45 days. Therefore, we know winter will come on average once a year it may be a mild winter or a rough one, but we know it’s going to happen. We plan for winter in real life so why not plan for winter in the stock market.
The only way to beat the storm with overwhelming certainty is to invest in a diversified index portfolio. I suggest a portfolio such as this one that invests in over 8,000 different companies and products. It is generally not a good idea to invest in individual stocks as they have the potential to crash and never recover. Never invest in individual stocks unless you are prepared to lose. A diversified index portfolio will never go to zero and will always recover-that is how you win! If you are, still working winter is the best time to contribute to your portfolio.
If retired or planning on retiring soon, in addition to the diversified index portfolio, we need a cash cushion.
In the previous post I mentioned to save a minimum of one year of living expenses in a high interest savings account. The longest bear market in history lasted 694 days, so we need to make sure our cash cushion lasts at least that long. During bear markets, the index as a whole still pays dividends. When we combine those dividends with our one year of living expenses, we have enough capital to weather the storm. Therefore, we do not have to sell any shares during a downturn-even through the worst storm in history-that lasted 694 days*.
We do not want to sell any shares during a downturn, in fact the opposite despite investor mood. I remember sitting down for breakfast at a restaurant with my extended family back in 2008. The over all theme was to sell investments and stay out of the market. Do not be like my extended family.
When you realize that winter comes every year it becomes your favorite season. Let me explain. If you have, $100 invested in the market and it drops 50% you would have $50. Simple so far. But we know now that the market will always recover so when it does it will increase by 100% just to get back to that original $100. If you continued to put money in the market during this hypothetical down turn, you would have doubled your money in a very short period of time (one year on average for this hypothetical bear market). As we move through this investor series I am putting $1,000 into the diversified portfolio every 2 weeks to show how easy investing really is.
How to win summary
- Do not be afraid of winter. Embrace it
- Plan for it with a properly diversified portfolio.
- Continue to put money in
- Don’t sell during a downturn
- Educate your self
*I excluded the 1929 stock market crash. This crash lasted 2.8 years. This is an extreme outlier. There are several factors that led to this crash, which are unlikely to repeat.