A reader recently reached out with a thought-provoking question:
What if the stock market experiences a significant downturn, say a 20% or 30% decline? While it wouldn’t be ideal, I’ve been investing for over 12 years, primarily using dollar-cost averaging. I like to think of such a decline as a “time travel” opportunity, allowing me to go back in time and invest at lower prices. Wouldn’t that be a good thing?
Interestingly, there’s a parallel between time travel and the stock market. Has there ever been a bad time-travel movie? I think not.
I often joke that Biff Tannen from Back to the Future II would have been better off with a stock market almanac instead of the Sports Almanac.
Relating time travel to the stock market can be a helpful way to put things into perspective. Let’s take a look at the chart:
If the U.S. stock market were to fall 30% from current levels, it would essentially take us back to January 2024. Considering the market’s historical performance, this might not be the worst scenario, especially for long-term investors.
However, a 30% crash could lead to a ripple effect, making a 40% downturn feel like the next likely step. This, in turn, would take the market back to May 2023. A 40% decline could then make a 50% crash seem inevitable, wiping out most of the gains from this decade and taking the stock market back to September 2020 levels.
Losses of 30-50% would undoubtedly be significant and might be a cause for concern. Such a scenario would likely require a substantial economic downturn or financial crisis to occur.
For investors who continue to dollar-cost average during a market crash, the short-term pain could be substantial, but the long-term benefits could be considerable.
It’s essential to remember that the stock market doesn’t operate in isolation. A crash often occurs in conjunction with a broader economic crisis or recession, which can have far-reaching consequences, including increased unemployment rates.
I recall a conversation with friends during the 2008 financial crisis, where one of them pointed out that those who kept their jobs would be able to continue investing in their 401(k)s at lower prices. As long as they had patience, things would eventually work out. However, those who lost their jobs or homes would face significant setbacks.
The old adage that a recession is when your neighbor loses their job, but a depression is when you lose yours, still holds true.
My friend’s insight proved correct. The labor market was slow to recover after the 2008 crisis, but those who kept their jobs, paid their mortgages, and continued making 401(k) contributions ultimately benefited greatly.
Investing during a market crash requires a combination of intestinal fortitude and careful consideration of one’s personal circumstances.
For net savers with a long time horizon, a 30-40% decline might not be the worst thing, as long as they can avoid experiencing a personal financial crisis.
We discussed this topic in more detail on the latest episode of Ask the Compound:
Other topics we covered included the pros and cons of buying bitcoin directly versus through an ETF, the comparison between crypto and tech stocks, the relationship between gas prices and recessions, and strategies for turning investments into a comprehensive investment plan, with input from Eric Balchunas.
1This conversation took place a few years after we graduated from college, got married, and started buying our first homes.
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