Life has been pretty busy this summer. We took a short trip to visit friends and family in California last month. We are back now, but life is still hectic because there are so many fun things to do in the summer. This year is busier than ever because RB40jr is also taking swimming lessons and learning how to ride a bike. Consequently, I haven’t paid much attention to the stock market. I noticed that our portfolio was down a bit in June when I did our monthly financial update, but I attributed that to the Greece financial crisis.
Then, I heard on the radio that the China’s stock market is crashing. That’s not good. My target asset allocation has 10% of emerging market so I should notice these big movements. Well, it looks like the China and Greece crisis affected our portfolio, but not that much. We have VWO and VEMAX (emerging market index funds) in our retirement funds and they declined about 15% from the high at the end of April. That translates to about 1.5% decline in our stock portfolio. The other sectors are up and down so our net worth didn’t decline much. In summary, the 30%-40% decline in the Chinese stock indexes didn’t affect us that much. It pretty amazing considering the China stock market lost over $3 trillion in value over the last 3 weeks and it’s probably not over yet. I’m glad our portfolio wasn’t impacted much, but it got me thinking – can we handle a 30% US stock market crash?
China’s Stock Market Crash Recap
Here is a quick recap of the China’s stock market crash for those of you who have been too busy this summer (our editor, Mrs. RB40 for one.)
- China’s Shanghai Composite index lost $3.5 trillion in value from its peak on June 12th to July 9th.
- Only 1.5% of the Chinese A shares are owned by foreigners. The Hong Kong listed H shares are down too, but less than the Shanghai market’s A shares. This limited foreign investors’ exposure to the crash. Whew!
- The Chinese government has been trying to prop up the mainland stock market, but hasn’t had much success until late last week. Beijing has reduced the interest rate, limited short selling, suspended IPO offerings, banned sales by large shareholders for 6 months, loosened leverage policy, and extended credit to brokers to buy shares.
- The rise of the stock market was fuel in part by huge margin financing (over $350 billion on margin). Basically, individual investors borrowed money to buy stocks. When the stock market crashed, investors had to sell to cover the margin calls. Many individual investors took out home equity loans and used peer to peer lending to fund their stock purchases.
- Roughly half of the companies listed have pulled their shares out of the stock market to prevent further drops.
- Stocks stopped trading when the share prices dropped more than 10%. This caps the drop to 10% per day, but you don’t know when it’s going to be over.
- 30 million new trading accounts were added in the first 5 months of 2015. Everybody and their cabdrivers wanted a piece of the action.
- The Shanghai Composite index increased 150% in value from June 2014 to June 2015, then dropped 30% since. Long time investors are still doing extremely well. The Shanghai composite index is up 85% compare to S&P 500’s 7% over the same period.
How we handled past stock market crashes
Okay, the news made the crash sound worse than it really is because they focused on the 30% drop. Long time investors have done extremely well and they don’t have anything to complain about. I don’t think this crash is played out, though. Let’s keep an eye on it and see how it goes over the next few weeks. The Shanghai composite index was up for the last 3 trading days, but I think it will resume dropping.
Back to my original question – what if the US stock market drops 30% in value? Would I panic and sell off stocks while the market is down? Let’s see what I have done in the past.
The dot com bubble in 2000
I started working in 1996 and invested in the stock market right away. At the height of the market, my net worth surpassed $100,000! That was huge for someone just a few years out of college. Unfortunately, I didn’t know much about the stock market and invested a large portion in Intel, my old employer. The stock hit $75 in August 2000, crashed, and went sideway since then. From this episode, I learned that I need to diversify. Also, I had to sell off some stocks when the market was down to cover the margin call. During the crash, I kept investing in my 401k, but stopped investing in my taxable account.
Lesson #1 – Don’t put all your eggs in one basket. Don’t invest too much money in your employer’s stock.
Lesson #2 – Don’t invest with borrowed money. I’m not smart enough to do that.
The global financial crisis in 2007
We were in a great financial position in 2007. We were both working and making good income. We didn’t have a kid, our monthly expense was reasonably low, and we didn’t have much debt. This time, our investments were more diversified and were not concentrated in one company or sector. However, we didn’t have much in bonds or other alternative asset classes. Our net worth declined about 25% during the worst of it, but we kept investing. I learned from the dot com crash that we should keep buying while the stock market was down.
Lesson #3 – Figure out your target asset allocation and stick to it. If you need help, read my asset allocation article and find a good financial advisor.
Lesson #4 – Keep investing through the bear markets, that’s when you build wealth.
The next stock market crash
The US stock market has been on the rise since early 2009. That’s a long time and we will see a stock market crash (10% drop within a few days) at some point. I have a feeling the next stock market crash will be more difficult for us than the previous two. I’m not working full time anymore so we won’t have as much money to throw at the stock market when it’s down. We can’t power though the next crash so we need to use a little more finesse. Our investment is much more diverse today and I’m pretty confident we will be able to handle the next crash. We have bonds, rental properties, REIT, foreign stocks, and cash. Our diversified portfolio should not drop as much as last time. Most importantly, I need to keep my head and don’t panic sell.
Lesson #5 – Start investing young so you go through a few stock market cycles with a stake in the game. This will help you figure out your risk tolerance and find your investing strategy.
Lesson #6 – Readers, do you have any tips for the next stock market crash? Should I hedge my bets with precious metals or invest in a hedge fund?
I love the stock market
The stock market is one of the greatest ways to generate wealth over time. I have been investing in the stock market for almost 20 years and it was very rewarding. I’m glad I started young because it took me a long time to evolve my investing strategy. Many Chinese cabdrivers are going to lose their shirts because they haven’t had time to become a mature investor.
Having gone through two crashes, I now have a solid strategy that I’m comfortable with. I’m not working full time anymore so I’m less aggressive and have more in alternative investments. A 30% drop in the US stock market should not cause a 30% drop in our net worth. Our net worth probably will drop 15-20% and I wouldn’t lose much sleep over that.
Do you think you can handle a 30% drop in the US stock market? Share you tips on how to handle the next stock market crash with us.
Passive income is the key to early retirement. This year, Joe is investing in commercial real estate with CrowdStreet. They have many projects across the USA so check them out!
Joe also highly recommends Personal Capital for DIY investors. They have many useful tools that will help you reach financial independence.