Managing Fears of a Market Crash
By Josh Scandlen
I often see fear mongering regarding an impending market crash. But the truth is the market has crashed before and it’s going to crash again. Nobody knows how much a future crash will be, or how long it will take for the economy to bounce back.
I joke that if you think the stock market is going to crash, you should just look out the window. But the truth is that you have two choices. You can choose to be in stocks and ride the wave or you can choose to sit it out.
Stocks do not always keep pace with inflation
Many stock market proponents will say that you have to invest in the market in order to keep pace with rising cost of living. But in reality, stocks do not always keep pace with cost of living. They did not keep pace with the falling cost of living during the Great Depression. And they did not keep pace with the rising cost of living between 1966-1982.
Between 1982-1999, stocks did great. It was a fantastic 18 years of low inflation and high stock returns. Over the last four decades we’ve had three of incredible market growth. But it’s important to remember there was a time when stocks did absolutely nothing.
In the 1970s if you reinvested dividends, you did make money – but not net of inflation. Even worse, you were taxed on illusory gains. So imagine you start with $100,000 and your stocks go up to $200,000 when you sell. You have to pay taxes on that $100,000 gain, even though it was a gain based purely on inflation, an increase in the price of goods which more than doubled over that same time frame, rather than the performance of the markets. So those gains required you to pay tax on phantom income.
Now I do believe in the stock market, and I believe in owning the companies of the United States. I like to think that there is value in investing in the companies that are creating the products and services that we’re always going to use. I just also believe that the assumption that stocks will always keep pace with inflation is pure speculation.
Are you prepared to wait out a market drop?
The point is, while I do participate in the stock market, I am always prepared for a major loss. In the first quarter of 2020 my personal portfolio was down about 30%. Thankfully I was not taking money out of my portfolio at that time, I still had income coming in. Today that money has all been gained back – plus extra.
But imagine if I was retired. Would I still have been comfortable waiting it out? It’s important to really think about this question. Don’t just say “yes, I can handle it, because the stock market has always come back.” That’s foolish.
Just because the market has traditionally bounced back doesn’t mean that is always will. That’s equivalent to saying the future is based on the past. We have no idea that a past pattern will continue – it does until it doesn’t.
Take the example of Japan in 1990. The NIKKEI is still lower today than it was on a price-to-price point from 1990. If you’re pulling money out of the NIKKEI, you’re destitute. Did the NIKKEI keep up the inflation even though there wasn’t hardly any inflation in Japan? No it did not. Market declines hurt much more than the increasing dividends.
When investing in stocks, you have to prepare yourself for the high likelihood that you’re going to deal with a 30% decline in your retirement savings – and that there’s no guarantee it’s coming back.
Alternative to investing in the stock market
When planning for retirement, let’s imagine you have $1 million. Now, say you need $5,000 a month in income, a total of $60,000/year. You get $30,000/year from Social Security, so that means you need an additional $30,000/year from your investment portfolio.
One option to eliminate a reliance on stocks is to go heavy on fixed income. You can do an annuity to reach that $30k/year goal. The drawback to annuities, or any fixed income, is that that income is literally fixed and will not give you increases at all.
If you’re ok foregoing any increases, you can rely on an annuity for that full $30k. Or, you can choose to go lighter on the stock market by putting $80,000 into fixed income and $20,000 into stocks. There’s a whole bunch of different ways to skin this cat. But the bottom line is that when you’re retired, you don’t have to be in stocks.
Yes, the idea of growth is attractive. But the truth is that history is replete with stock market crashes. And if you’re pulling money out to live on and the stock market crashes, you’re going to be in a world of hurt.
Bonds are another option that historically won’t crash as hard as stocks. Theoretically treasury bonds are the risk-free security, and are guaranteed not to go bankrupt. Will they maintain guaranteed purchasing power? There is no way to say. But you can use your common sense and make the choices that seem right for you.
Don’t stress – make a plan
At the end of the day, it’s pointless to panic about a potential market crash. All you can do is decide if you are comfortable being part of the stock market system, or not.
If you decide that yes, you are comfortable, then that means you should also have a Plan B in the event of a crash. Ideally, that Plan B is that you are not going to touch your stock holdings when it goes down.
If you have $1 million in the market and the market crashes by 40%, you are preparing to be down $400,000. It’s easy to say that you are comfortable riding out a 40% plunge, but keep in mind that imagining it in theory is different than facing it in reality. In reality, you don’t know when you’ve hit the bottom. Just because you’re down $400,000 doesn’t mean the damage is done. You can only bite your fingernails and guess.
Hindsight is easy. But when planning for the future, we’re not looking at hindsight. We’re looking at foresight. What is coming down the road, and how do we prepare for that? Only you are going to pay those bills. Only you are going to face those choices. So don’t let yourself be bullied down any one path. Do what you need to do to help you sleep comfortably at night.