If you watch or read any financial news, you’ve probably seen stories commemorating the 10-year bull market that’s been running since the end of the Great Recession. Many of the stories have focused on one particular sound byte: if you had invested at the bottom of the Great Recession, you would have made a lot of money over these past 10 years. That’s certainly true, but let’s parse things out a bit.
Here’s a recent chart of the S&P 500, showing you the performance of a broad stock market index from the beginning of March 2009 to March 2019.
If you had invested $100K at the beginning of March 2009, 10 years later, at the end of February 2019 and assuming reinvested dividends, your $100K would have turned into $460K! Wow, what a return!
So, what’s the takeaway? Just wait for the market to bottom out, invest your money and you’ll be rich in 10 years’ time. Sounds simple, right?
Now, let’s play a game.
The prior chart had a starting point right at the S&P 500’s lowest point during the Great Recession. I know that because I had the benefit of looking at historical data.
If you had money available to invest during the Great Recession, how would you have known that March 2009 was the market bottom and that it was time to invest your funds? Hint: if you’re hoping for me to tell you how, you’ve come to the wrong place.
Round One
Take a look at the following chart:
What do you think? The S&P 500 index has dropped pretty dramatically. Has the market hit bottom? Let’s say you have $100K sitting in the bank ready to invest. Is it time to deploy your funds?
The above chart reflects a real life two-week trading period between August 28 and September 17 in 2008. In just those few short weeks, the following events happened: Fannie Mae and Freddie Mac were nationalized, Merrill Lynch was about to go insolvent and got acquired/rescued by Bank of America, Lehman Brothers filed for bankruptcy and AIG took an $85 billion dollar bailout from the government. Surely, the stock market can’t fall any farther than it has after all this bad news.
Would you have had the intestinal fortitude to put your $100K into the market? Not me. I lived through this and didn’t cheer when Lehman Brothers filed bankruptcy and stocks became cheaper to buy. On the contrary, like many others, I was on the edge of my seat wondering if the world financial system was going to come crashing down.
But, let’s say you answered Yes, that this would be a good time to invest. By the end of February 2019, just 5 months later, your $100K is now only worth $61K. Ouch.
Would you have been able to resist the urge to cut your losses and sell? Would you have gotten out a month earlier in January, when your portfolio was still worth $68K? Or 2 months earlier in December, when your portfolio was worth $75K? Or, would you have bailed out just a month after making your investment when your $100K dropped to only $77K?
Round Two
Let’s take a look at another chart:
What do you think? Has the market hit bottom? Is it time to invest your $100K?
In the above chart, the S&P 500 has dropped almost 30% from the start of the period to the end.
What this graph shows is the S&P 500 from September 19, 2008 to October 10, 2008. In just a short 3-week period, the S&P 500 has dropped dramatically.
Surely, the market has hit bottom after taking into account both this 30% drop and the prior big drop from August 28 to September 17 that we saw in the earlier chart from Round One, right?
Well, $100K invested on October 10, 2008 would only be worth $75K by March 9, 2009. Yikes. Remember Round One? If you had said in Round One that you would have invested your $100K on September 17, your $100K has now shrunk to $56K. Double Yikes.
Round Three
Let’s do another one:
What do you think? Has the market reached its bottom? Is it time to invest your $100K?
Look at the red trend line that I included with the chart. It’s red! It’s scary! I made it red so that it would look extra scary!
Well, if you answered Yes and invested your money, congratulations! You timed the bottom of the market for the S&P 500 in the worst financial crisis in 80 years. In doing so, you would have looked at this chart, which shows huge losses over a more than one year period from January 2008 to March 9, 2009, and despite the meltdown of the economy and financial system, wide-scale layoffs and overall sense of societal doom and gloom, you showed the courage to invest and you would have been rewarded. By March 2019, your investment would have quadrupled in value.
But, I’m willing to guess that most of you who were around and investing during this time period didn’t identify the market bottom. And, even if you did, I’m guessing you probably didn’t invest a big lump sum at the market bottom. In fact, I would argue that it’s highly improbable that anyone beyond chance would have picked both the market bottom AND also have the guts to make a big bet.
Now, let’s change the rules of the game just a little bit. Instead of a scenario where you’re trying to decide whether the market has reached bottom and it’s now time to deploy your $100K, let’s say you already have much of your life savings invested in the market. Ask yourself: would I have been able to keep my money in the market as it’s dropping in value starting with being down 10%, then 30%, then 50%….years and years of savings lost in weeks’ or months’ time. Is there a point where I am going to cry “Uncle” and get out of the market?
A Mini Memoir
In retrospect, I had the great fortune of working and investing through the Great Recession relatively unscathed and seeing the recovery that followed. I learned a lot about my own risk tolerance. I didn’t have a whole lot invested back during the Great Recession, but it sure felt like a lot then.
When the stock market started going down, I kept contributing to my 401(k), which I had invested in a stock index fund. I knew things were really bad when the credit markets froze in September 2008 and every project I was working on at the law firm came grinding to a halt. As the stock market kept going down, I dollar-cost averaged modest amounts into a taxable account.
However, as the stock market kept going down and down and widespread fear settled in, I stopped contributing to my taxable account. I hung on for dear life and didn’t sell anything. And, when the trend line started reversing and the markets began to recover, I continued staying on the sidelines. Much longer, in retrospect, than I should have. But, that’s what 50%+ drops in stock prices can do to a person. I left a lot of money on the table (and perhaps the Money Blawgger would be the Retired Money Blawgger by now).
Now, 10 years later, I still assess my tolerance for risk. I have more assets than I did 10 years ago, and my tolerance for risk has changed. My need to take risk and invest in higher-yielding, but riskier assets in order to meet my financial goals is not as great as it was 10 years ago.
My willingness to take risk has decreased. For me, the happiness I get from making an incremental $100K would be outweighed by the angst of losing $100K (in behavioral finance, this is called loss aversion).
So, What’s the Point?
- Timing the market is hard – during the Great Recession, there were many points when it looked like a market bottom may have occurred, but the market kept going down
- It’s especially hard to time a market bottom and take action and invest when the world feels like it’s about to end
- And, if you already had money in the market, you would have been dealing with a real-life question of whether you could tolerate the huge drop in stock prices
- Investors with asset allocations closely tied to their risk tolerance would have been more likely to withstand the urge to panic and make drastic changes (like getting out of the market) and then subsequently enjoying the benefits of the big recovery that followed
Yes, we just went through a great 10-year bull market, but don’t forget what preceded it. Investing in stocks is risky. It might not feel that way over the past 10 years, but the risk is there. Just in the last two decades, it’s shown up twice in the United States – with the Internet bubble crash and the Great Recession. But, this is where opportunity comes from too.
In order to take advantage of the wealth-building opportunities in the stock market, you have to first understand your tolerance for risk – your ability to suffer permanent losses, your willingness to risk your assets and your need to take risk. Can you really put 100% of your portfolio in stocks? Really be honest with yourself.
Each investor has to determine his or her own tolerance for risk. When stocks have gone up for 10 years and the news media is celebrating the amazing returns achieved by investors and friends, family and co-workers are talking about all their great investments, it’s easy to think that you can tolerate a lot of risk in exchange for opportunities to get high returns. But, what the Great Recession showed was that risk does rear its ugly head, and it can come suddenly and unexpectedly.
