It’s sometimes hard to be a long term investor. The stock market moves up slowly but can drop quickly.
The pain of loss has more impact than the elation of gain.
The long term investor who entered the market after 2008 has had a pretty good run.
That’s why days when the market drops a few % feel so foreign and scary.
However, the long term investor must know that things can and likely will get a lot worse. It might not happen this week or this year but eventually, this bull run will come to an end. There will be days and weeks and months like today.
However, the long term investor, should also know that a drop like that might not be so bad in the long run.
It takes a strong stomach to sit through those times and stay invested. However, that’s the best way to make money in this market.
The worst enemy to long term returns is selling at the wrong time. Many people think that buying at the wrong time is the problem. However, that’s rarely the case.
The case for being a long term investor
Let’s imagine an unlucky investor who had some money to invest and saw that the market in 2007 was rising.
Ms. Unlucky heard all about the great returns from the market and wanted to set herself up for a good future. She didn’t have a lot of knowledge about the market. However, a colleague told her that an S&P 500 index fund would give her stock market exposure and she could set it and forget it.
She even spoke to Mr. Risk Averse who said the stock market was a fool’s game and that everything was going to crash. He had been mostly out of the market for years and missed all the gains and he wasn’t about to get in now. He had a few stocks but nothing big. It was too risky and overpriced!
He recommended putting her money under a mattress; or if she wanted to get crazy, maybe a bond fund.
After these discussions; she read some books, learned about the risks involved with stocks, decided she was comfortable with those risk and put a part of her money she didn’t need for the next decade in the market. She was young, had a long term horizon and had some cash on the side in bonds and savings accounts already.
It was time to dive into the world of stocks.
Ms. Unlucky took $100,000 and put it in the market on October 9th, 2007.
You know what happened next. October 9th, 2007 was the day the stock market peaked. That began a long term decline that didn’t end until March 9th, 2009.
The graph below shows what happened to Ms. Unlucky and her investment of $100,000.
Including all dividends, the peak to bottom drop was 55.2% meaning Mrs. Unlucky’s $100,000 quickly became $45,000.
Mr. Risk Averse was the first to point out how smart he was. “I told you so,” he said as his bond fund grew a little bit and he sold off all his remaining stocks at a big loss vowing to never get back in.
Ms. Unlucky shrugged. It took an iron stomach to deal with the big drop but she knew what she was getting into when she invested. This was money she didn’t need and after reading all those books, she knew this was a possibility.
It sure was bad timing to get in at what seemed like the top but this had happened many times before. And after all, the stock market has a long term trend and that trend is up.
“This time is different, things are still overpriced” said Mr. Risk Averse who was even more confident about his decision to never invest in stocks.
In a way, Mr. Risk Averse had been right in the short term. The stock market did move south but this wasn’t a short term game, it was a long term decision.
There might have been an inkling of doubt in Ms. Unlucky but she pushed it down and carried on. When she made the decision to invest, she had at least a 10 year timeline and what had changed? Nothing, in fact, stock prices were lower now and her 401k contributions continued to go in the market. She even started a new Roth IRA account with some extra money she had.
The fact that her initial $100,000 had shrunk didn’t change much in her life.
She was lucky enough to keep her job and kept moving on. She didn’t pay much attention to financial news and concentrated on her hobbies instead.
March 9th, 2009 passed. Things looked bleak and people said it was going to get worse. Ms. Unlucky just decided to stop paying attention to the financial news. The talking heads there just screamed and yelled. It wasn’t all that interesting to her because who cared what happened to the stock market in the short term.
Even though no one knew it at the time, that day was the bottom.
Ms. Unlucky concentrated on her job, her life, she met a great guy and worked on herself as a person.
The days passed and Ms. Unlucky was happy enough to ignore the financial news until she spotted a news article the other day. The Dow had “crashed” 800 points, a whole 3% and everyone was panicking again.
She thought back to those days 10 years ago and wondered how that $100,000 she had invested was doing. You know that same, $100,000 that she invested at the market top that fell to $45,000 just a year later?
Well, it was doing pretty well.
She now had nearly $225,000 in that account. That’s without adding any additional dollars beyond her initial $100,000 contribution.
Despite dropping 55% from peak to bottom, that account had still yielded an annual return of 7.6% even including yesterday’s drop.
The S&P 500 closed was near 2800, a big jump over that the 1565 she bought at during the “peak” in 2007.
She smiled. She was married now and her name had changed.
That $225,000 wasn’t all the money she had. There was a 401k too and a Roth IRA she started years ago. Contributions had been flowing into those accounts during the drop in 2008 and the subsequent rise after 2009. She was older now so she added more bonds to her allocation. After all, the stock market can sometimes take longer to recover than it did in 2008 but she knew that if the stock market dropped, she’d be OK because she was still a long way away from needing that money.
She told this to Mr. Risk Averse whose bond account trailed hers quite a bit despite her buying when things were “overpriced” at the very peak in 2007.
He had never gotten back into stocks as every time he looked, he thought they were bound to crash.
“Maybe it’s time to get back in,” he said to her as she walked away to go have dinner with her husband and new namesake, Mr. Lucky.
Sometimes, you don’t have to have good timing. Even unlucky investors who buy at the top can get pretty lucky and have good returns. All it takes is patience and a long term mindset.