The answer is simple.
By Being an intelligent and educated investor, by understanding key principles of investing, and historical trends of the market, all these elements will go a long way in removing investment panic and anxiety.
Some people have very valid questions, like:
What if the stock market drops 50% in value as it has done in the past?
What if the market drops while I’m in retirement?
Should I sell if the stock market starts going down?
Will I lose everything? Will my retirement be derailed?
It’s absolutely normal and even a positive sign to be concerned about these issues.
It would be more of a concern having an investor who never think of these scenarios than someone who had these questions and got solid answers to them.
So let’s explore the scenario of a stock market drop.
Because it happens. It’s happened in the past and it will happen again.
Maybe next year, or next month, or even tomorrow.
How often does the stock market drop?
Everyday the stock market fluctuates.
On certain days it trends up and other days it trends downward.
The analysis of the past 20 years’ worth of data and found that the stock market was down almost 47% of the days.
So, about half the time, the market is up, and half the time down.
But over that same period of time the stock market value has increased by 331%!
How often does the market have BIG drops?
Stock market declines of 10% are considered a “correction”.
Believe it or not, these corrections tend to happen every few years and they are considered a normal part of an economic cycle.
When we start getting into five or more years without a stock market drop, investment analysts start expecting it.
When the stock market drops 20% or more that’s considered a “bear market”.
These bear market conditions are less common but still tend to happen at least every ten years or so.
Aren’t these big drops a concern for investors?
Over the past twenty years, there have been two huge bear markets – a drop of 49% from 2000 to 2002 and a drop of 56% from 2007 to 2009.
And recently in March 2020 drops 35% in two weeks.
But, during this same twenty-year period, stocks are up a total of 331%.
So starting in 1997, near a market high right before the “dot com crash”, and running into January 2017, the stock market has returned an average of 7.58%.
Yes, that is a good bit below the lifetime market average of 10%, but consider this: With a 7% average annual return your money will double every 10 years. That’s still a really good return!
How long do these corrections and bear markets last?
The average bear market and correction lasts 15 months.
Please understand that doesn’t always mean a return to full value within 15 months though.
I want to make sure you have proper expectations.
On average the down cycle will last 15 months and then the market will enter an aggressive recovery period.
After the “great recession” of 2007-2009 ended, there was a four year stretch of recovery and the market reached a new high point in 2013.
Investors who waited two years saw the value of the investments start to rise again. Most investors who sat tight and waited another four years had all their investment value back and even more!
After the drop in March 2020, the investors saw their investments soars about 50% in few months.
Can I “lose everything” in the stock market?
This is the same thing as asking if the stock market value will ever drop to zero.
No, it won’t. Specific individual stocks might drop to zero if the company goes out of business.
That’s why you should always have a diversified portfolio– to balance out the risk any single stock might present.
But if it is down 50% I’ve lost half my money.
No, not really. If you sell your investments while they are down 50%, then yes, you lock in a loss on that money.
That’s why investing should always be planned for a long timeline
What if the stock market drops while I’m in retirement?
This is a very real concern and people who are approaching retirement need to think about this.
Many investment advisors will recommend their clients shift money from stocks to bonds as they approach retirement.
The problem with that advice is that bonds have horrible returns.
If you still need your investments to grow, as most people do when entering retirement, then bonds are going to work against you.
What’s the solution then?
Staying invested in stocks.
But you also need to make sure you have adequate cash reserves (aka emergency funding).
Once you move into retirement or whatever point in your life that you want to start living off your investments, you need to consider expanding your cash reserves.
As mentioned above, the average stock market downturn lasts about 15 months.
Within a few years, there is often a substantial recovery from the stock market drop.
To avoid having to sell investments while they are down, people who are in retirement should expand their cash reserves so they can ride out market dips.
Having enough cash to cover all of your living expenses for at least two years, perhaps three or more if that makes you feel better, will allow the rest of your money to stay invested in stocks while also lowering some of your risks.