On 2/5/08, the Dow Jones dropped 1,175 points, or 4.6%. Three days later, it dropped another 1,032.89 points—an additional 4.1%. What should you do? Sell? Buy? Something else?
WHEN STOCKS TAKE A DIVE
TAKE THE LONG VIEW
Assuming you use the stock market as an investment tool (rather than a gambling opportunity), you should take the long view. Suppose we were in a bear market, with stocks down more than 15% from a recent high. Sound bad? Consider this. Since the 1930s, bear, or down markets have lasted 18 months on average. Bull, or up markets have lasted an average of 97 months. This means that up markets tend to happen five times more often than down markets, and tend to last five times longer. No one can promise this trend will continue, but it has been the average pattern for 80 years. Implied policy: buy and hold.
A CASE IN POINT
Suppose the markets drop 10%, and the funds you own fall by $30,000. Have you really lost $30,000? Not unless you sell your stock at this point. Only your statement balance has gone down. And if long-term history is any guide (and you’ve invested sensibly) your balance is very likely to go back up. Provided you don’t sell. Implied policy: buy and hold.
Stock market returns are governed by three factors: earnings growth, dividends, and speculation. According to a study by financial analyst Jon Eickmeier, 100% of long-term returns come only from earnings growth and dividends. Speculation drives stock prices during short periods of a few months to a year, causing a bubble that ultimately bursts (as we saw in 2000 and 2008).
BUBBLES DON”T LAST
From 2012 through 2014, the Standard & Poor’s 500-Stock Index (S&P 500) rose at over 18% a year. Yellow lights should have flashed in your head, because that’s far above the long-term return of the broad U.S. stock market. Probably, some of that gain was just a bubble, and so, when the bubble finally burst, you weren’t surprised. After all, you were expecting a correction.
And even if the correction took you all the way back to the long-term return of the broad market, you’d still be doing well. According to a dqydj calculator, the S&P 500 has returned about 10% with dividends reinvested from 1960 through 2017. At that rate your money doubles in 7.2 years, not counting the impact of inflation, which rises at an average annual rate of about 3%. (Note: The average rate for the 10-year period, 2008 -2017, was less than 2%, mostly because of globalization.)
The most interesting point remains the remarkable growth of the Dow Jones industrial average from 1,738.74 on October, 1987, to over 20,000 in February, 2018—impressive growth by any standard. Implied policy: Never try to time the markets. Instead, buy and hold.
This article has been reviewed for accuracy by Richard E. Evans, Financial Editor.