A reader asks:
I just started investing in 2020 and this is my first real improvement. I know a recession is inevitable, but how long do you think it could last? Should I change the way I invest now as my portfolio is running out?
It’s probably a good time for a review as it’s been a while.
Last year the biggest correction in the S&P 500 was just 5.2%.
As of Wednesday’s close, the S&P 500 was down 5.5% from its highs. It’s still a relatively small loss in the grand scheme of things, but we’ve already passed those small improvement levels from 2021 onwards.
Other parts of the market are selling out even more. The Nasdaq 100 is down more than 9%. Smallcap stocks are down about 16 per cent.
It is important to remember that this is just something that happens from time to time in the stock market.
The only reason you get higher returns in the long run is because you sometimes experience losses in the short term. This is a feature, not a bug.
The average decline from peak-to-trough in a given year in the US stock market going back to 1928 is -16.3%. And you may see double-digit improvement two-thirds of the time at some point during the year:
All crashes in the 1930s have skewed these averages slightly, but even in more modern times, losses in the stock market are a regular occurrence.
Since 1950, the S&P 500 has declined an average of 13.6% over the course of a calendar year.
In this 72-year period, based on my calculations, there have been 36 double-digit corrections, 10 bear markets, and 6 crashes.
This means, on average, the S&P 500 has experienced:
- Improvement once every 2 years (10%+)
- Bear market once every 7 years (20%+)1
- Accident once every 12 years (30%+)
These things don’t happen on a set schedule, but you get the idea.
The S&P 500 is probably the least volatile of all the benchmarks, so it may help to look at other areas of the stock market as well.
The more tech-heavy Nasdaq Composite Index goes back to the 1970s. I count 25 improvements since 19702, 12 bear markets and 7 outright crashes.
This means, on average, the Nasdaq has experienced:
- Improvement once every 2 years (10%+)
- A bear market once every 4 years (20%+)
- Accident once every 7 years (30%+)
The Nasdaq has also experienced much deeper crashes than the S&P 500.
For example, during the brutal bear market of 1973-1974 when the S&P 500 fell 48%, the Nasdaq fell 60%.
And while the S&P halved by 50% during the 2000-2002 crash, the Nasdaq was down a bone-crushing 78%.
Small cap stocks are also more volatile than large cap stocks.
The Russell 2000 Index of Small Companies goes back to 1979. In that time there have been 22 corrections, 12 bear markets and 7 crashes.
This means, on average, the Russell 2000 experienced:
- Improvement once every 2 years (10%+)
- A bear market once every 4 years (20%+)
- Accident once every 6 years (30%+)
And while the S&P 500 has had just one bear market since 2009 with losses of more than 20% or more (in 2020), the Russell 2000 has seen four bear markets:
- 2011: -29.6%
- 2016: -26.4%
- 2018: -27.4%
- 2020: -41.6%
There are two different ways to look at the increased volatility of these other areas of the market.
On the one hand, higher volatility can have a psychological effect on investors and increase the chances of making a mistake.
On the other hand, greater volatility means more opportunities to buy or rebalance at lower prices.
These improvements are a good thing if you’re saving money regularly. This means that you are buying stock on sale. Young investors should prefer down markets when they are in accumulation mode.
The truth is we don’t know how long this reform lasts.
Bear markets and crashes are rare. If history is any guide, it is more than likely that this is just a routine improvement as opposed to the end of the world.
But a bear market is always possible when humans are included in the equation.
I think there are some investors who can switch their strategy from bull markets to bear markets, but I haven’t met many people who can do so consistently.
I am a big fan of creating a portfolio that improvises and takes the markets into account when you create your investment plan. You should strive to create a savings and investment process that is sustainable enough to handle both the up and down markets.
We discussed this question on this week’s Portfolio Hedge:
With the help of my friend Tony Isola, we also answered the questions of how much diversification is enough, planning for financial aid when sending your kids to college, and what accounts to open for your kids when you want to start saving. .
1A bear market is technically defined as a loss of 20% or more. It’s kind of crazy how there are 5 different instances where the S&P fell and turned 19% but never actually closed 20%. Horseshoes and grenades I guess.
2It’s possible that my correction numbers are a bit low here. It’s hard to separate a correction from a crash when you have a period like the dot-com implosion in which the Nasdaq fell nearly 80%. These things are subjective in some ways.
