I am a fan of the ChooseFI podcast, and they recently had blogger and author JL Collins as a guest. He is the writer of a popular personal finance blog and author of The Simple Path To Wealth. I thoroughly enjoyed this interview, and I particularly liked his summary of market history from 1975-2015. Despite all of the economic and political crises the world has experienced over the past 40 years, the stock market has performed extraordinarily well. A prudent investor should hold and purchase stocks through all of the ups and downs of the market.
Should Young Investors Root For A Bear Market?
However, I did disagree with one statement during the interview. Here is the transcript of the podcast, starting at approximately 16:24 (emphasis mine).
If you were a young investor, just starting out, or just a few years in, the very best thing that could happen to you is a stock market crash, assuming that it doesn’t scare you away and assuming that you keep working and you keep investing because you are buying stocks at lower prices. You’re buying them on sale at bargain rates, so anybody who is listening to this who is young and just starting, you should be rooting for the stock market to take a plunge.
He argues that young investors should actually hope for a bear market, because that means they will subsequently be able to purchase stocks at lower prices.
For example, people who started working in 2007 were able to purchase many shares at low prices in 2008-2009. Because we don’t invest all of our money at once, but rather invest it slowly over time (investing a portion of each paycheck), corrections allow us to purchase stocks at lower prices than they were before the bear market.
Let’s look at the chart of the S&P 500 from 2007-2017. Assuming that you purchase shares continuously over this period, would you rather have had a market that goes up in a smooth line, or the turbulent market that we actually had?
Certainly, you would have slept better at night if the market went up in a straight line, but you would have preferred the turbulent market that we actually had. You were able to purchase many more shares at lower prices because we had a bear market early in this time period.
For the math geeks out there, you’ll notice that your profits over this period would be equal to the area “under” (or in this case, over) the curve, since you were purchasing the stocks continuously over time. Therefore, you prefer Scenario 2 over Scenario 1.
A Bear Market Changes The Final Destination
However, a key assumption of the argument to root for a bear market early in your investing life is that the stock market will eventually end up in the same place. In this case, you prefer a down market early in your career rather than late in your career.
This assumes that after a bear market, the stock market will recover and make returns as if the bear market never happened. It assumes that the stock market has a final destination, and we are simply rooting for a circuitous (down then up) rather than a straight path to that final destination.
I think this is incorrect, because in a bear market, we should not expect to recoup our losses quickly through a period of higher-than-normal market returns. Of course, we should expect positive returns, but not higher-than-expected market returns.
If the market had only typical positive returns after the bear market, then we would have preferred that the bear market just never happened.
Sequence of Returns Risk is Real
I agree that if you must have a bear market, you would rather have it early in your investment career when you have not invested much money, than later in your career, when you have all your career savings invested.
Going back to our original example, the worst case scenario is to have the stock market go up a lot, but then crash right before or in the early years of retirement. This is commonly referred to as sequence of returns risk.
But the fact that you had a bear market early in your career makes it more likely that you will experience a second bear market in your career. The likelihood of future bear markets is independent of the timing of past bear markets.
Investing Is Mostly Psychological
This is really just an academic disagreement, as we agree on how people should invest their money. Specifically, both of us agree that people should invest throughout their career. People should invest in up markets and down markets, and not panic when the stock market has a correction, recession, or bear market. I just don’t think investors should be rooting for a bear market.
So much of investing is psychological, and if the notion that you are buying stocks on sale makes you feel better about purchasing stocks in a bear market, then use this logic. So many people fear of getting into the stock market when it is falling, causing to make them the significant error of not continually investing their money throughout their working life. Others will hesitate to invest in the stock market when the stock market has risen, because they worry that a bear market may be on the horizon.
In summary, young investors should root for the stock market to go up, not down. But as JLCollins recommends, invest early and invest often. If the stock market goes down, keep on investing. If the stock market has been on a long bull market, keep on investing. Never stop putting your money to work for you.
[Charts courtesy of StockCharts.com]