The stock market has been very unpredictable this year. At the beginning of 2020, nobody thought it would fall 35% so quickly. That was the fastest drop of this size in history. Then, the stock market came roaring back and recovered most of the loss over the last 2 months. It was the fastest recovery from a market low since the Great Depression. How did that happen? The COVID-19 pandemic is still growing and over 40 million Americans filed for unemployment benefits since it began. To top it off, there have been protests against inequity in every state. The economy is really struggling and the Nasdaq-100 index hits a new high? That doesn’t make any sense to me. And we’re not even halfway through 2020. Who knows what the next crisis will be? The stock market could crash again or it might keep going up. What should a regular investor do in this uncertain time? Well, I don’t know what the stock market is going to do next, but I can recommend what a long term investor should do. Read on!
Learn from my mistake
Everybody makes mistakes. The important thing is to learn from them so you don’t repeat the same mistake. I started my engineering career in 1996 and my dad convinced me to save for retirement right away. That was great advice. Thanks, Dad! After a few years, I was able to max out my 401k contributions and I was on my way to financial independence.
However, I made a big mistake in 2000. The Dot Com bubble popped and the stock market crashed. My stock portfolio was losing money daily. I got scared and stopped investing in my retirement account for almost a year. When you are a new investor, it feels very difficult to invest more when your portfolio value keeps going down. At least I didn’t sell all my stocks when the market was down. That would have been disastrous.
Eventually, the stock market bottomed out and I maxed out my contributions again. Some of my friends sold their stocks and got scared off of the stock market for years. We missed out on a great investment opportunity. If we had kept investing during that crash, our investment would be worth more than 4x the money we put in. We also missed out on the retirement account tax deduction and company matching. We thought we were smart to avoid losing money, but we were wrong in the long term.
Fortunately, I learned from my mistake. The stock market crashed hard when the global financial crisis hit in 2008. That time, I didn’t flinch. My wife and I both had steady income so we felt reasonably secure. We invested all of our extra money during that recession.
I knew that during a recession is the best time to invest. You can buy more shares with the same amount of money. We were young and we wouldn’t need our retirement accounts for many years. In that situation, you should invest as much as you can in the stock market.
Don’t stop investing
2020 is no different. We are older now, and we won’t need to draw down our retirement account for at least 10 years. Like in the last recession, we kept investing when the market crashed. We also invested more when it was recovering. No matter what happens next in 2020, we will keep investing. Short term volatilities may cause the market to buck wildly this year, but this gyration won’t matter in 10 years.
In fact, the perfect time to buy more stocks is during a recession. When you invest during a recession, your purchase price is lower than normal. The stock market should recover at some point and your steadfastness will pay off. Here is a quick look at my son’s Roth IRA.
His portfolio balance decreased sharply in March, but it recovered very quickly to reach a new high! Last week, it dropped a little. But in 40 years, it won’t matter what happened in 2020. His investment will be worth a lot more due to compound interest.
More scenarios
Of course, everyone is at a different point in life. Investing more at this time might not be a good idea if you need money to pay bills immediately. Let’s look at a few scenarios.
Young investors – If you’re young and just started investing, it’s best to focus on increasing your investment. Try to max out your 401k contributions as soon as you can. Don’t worry about the stock market volatility. It won’t matter in the long term.
Experienced investors – For those of you who have been working and investing for a while, it’s crucial to figure out an asset allocation you can live with. This recent stock market crash is a good test. If you own a lot of stocks and can’t sleep at night, then you probably need to invest more conservatively. My target asset allocation is 80/20 (stock/bond) and I have been able to ride out the stock market crash without stressing out too much. Also, when the stock market crashes, you should rebalance. This will force you to buy more stocks when the price is down. That’s good for the long term.
Near retirement investors – If you’re planning to retire soon, you will need more cash cushion and probably should go with a more conservative asset allocation. Most early retirees in the FIRE community have at least one year of expense in cash. This will enable them to avoid selling stocks when the market is down. We also have a good percentage of our assets in bonds. If we need cash, we could sell bonds instead of stocks. Once the market recovers, we can rebalance back to our normal asset allocation.
Keep investing
In a crisis, our natural tendency is to conserve cash. This instinct becomes even stronger when we see our portfolio drop each day. It might seem smart to sell stocks and keep the money in cash because the balance won’t decrease so much. However, you don’t know when to buy back into the stock market either. I think a lot of investors missed this recent run-up. The stock market recovered back so quickly.
In conclusion, long-term investors should continue to invest during a recession. It’s a good chance to buy some stocks at a bargain price. In 10 years, your portfolio will be worth a lot more if you do.
What do you think? Did you continue to invest when the stock market crashed earlier this year? It’s hard to buy when the stock market is falling, but it usually turns out really well for the investors who keep investing during a recession.
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.
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Dollar cost averaging into S&P 500 is the way to go regardless if the index is at an all time high or just after a drastic drop.
There are very few people who can time the market and make out better than just dollar cost averaging into the index.
Play the high percentage bet and just DCA. Don’t try to time the market.
Great job! Every investor should do this.
This is very good advice. Markets are definitely cyclical in nature and bull markets are always followed by bears, which are then followed by the next bull market. That much is totally predictable, it’s the timing of each that is unpredictable, unfortunately. Hence a continuous investment strategy is the answer. (Dollar Cost Averaging)
However, it is also advisable during these times of economic stress not to be too swayed by a particular shares lower price in relation to what it may have been before the crisis. As Warren Buffett has said in the past “when the tide goes out, you get to see who is swimming naked”. Therefore, there may be some very valid fundamental reasons a share price is collapsing as opposed to just the general market malaise. So stay cautious and do your research.
I’m relatively young and got furloughed at the beginning of the pandemic, so I quickly started saving as much cash as possible, and built up my cash savings to about $15k, which is about 9 months of expenses for me.
Now that I’m employed again, and I expect the stock market to go into a recession soon, my plan is to open a brokerage account and start investing in ETFs using stop-limits and regular contributions, in order to try to take advantage of market crashes.
Nice job! $15k is a good amount of cash cushion. Keep investing!
This has been a been a real key to my success as well. Didn’t make much money from 2000 to 2009 due to the two crashes, but the last decade has been a great one. Still have 15 years until 59.5 which would be the earliest I’d tap into the investments, but we’ll probably avoid it.
We invested from 2000 to 2009 and it worked out very well in the long run. Those investments were a lot cheaper back then.
The stock market went up a lot since then.
Such an important lesson to learn. Similarly, I pulled back my investing during the Great Recession. That move probably cost me $30-40,000 🙁 Thankfully, I learned my lesson this time around.
i really like the link to asset allocation. i really think it’s a big deal. i learned a lot about myself with that recent 30% drop. it didn’t bother me too much. i rebalanced a little near the bottom and bought one stock. however, my young protege was able to put in fresh money in march and all those stocks are up 40% or more. i told her not to expect that all the time.
That’s great. I wasn’t stressed out either. I think that comes from experience and financial security.
It’d be a lot more difficult to keep investing if someone was unemployed, for example.
That’s the right message for sure! I was oblivious to what the market was doing when I was young and stupid, but that was a good thing. I just kept putting money in over the decades and not watching what it was doing. That turned out to be a very smart move and probably the biggest catalyst in us reaching FI.
That’s a great way to invest too. Don’t pay attention to the market and keep investing.
Great strategy. My portfolio is almost 100% stock as I don’t need that money for at least 10 years. We have about year worth of expense in savings. I am buying every week slowly to get best out of DCA strategy.
I agree with what Mr. Tako stated that when it bottoms is the time to be greedy. This is why I would also recommend that everyone have a ROTH I.R.A. because if you don’t have the money at the exact time the market bottoms, then you can always convert stock from your traditional I.R.A. or 401k to your Roth account. You don’t have to pay taxes on the conversion until next April. It is like an interest free loan. If you owned mastercard, it was in the $300’s before the crash. If you transferred it to your roth in the low 200’s (bottomed at $200), then you would pay income tax next April on the that amount. It is already back up to $300.
That’s a great strategy. I didn’t do it this time, but I’ll put it on my playbook for next time. Thanks!
Questions regarding “balancing”:
(1) How often do you recommend we rebalance? (Should we time the market to rebalance?)
(2) If one were 100% in equity, does that mean no rebalancing is needed?
1) It depends on your experience. If you are not comfortable buying and selling stocks, then just rebalance twice per year. If you don’t mind buying when the stock market drops, then rebalance when you see good opportunities. Most experienced investors I know purchased more stocks when the market was down in March.
2) No need to rebalance if you’re 100% stock. Just keep buying.
My system is maybe less conventional than most. In 2016 I projected retirement in 2030, assuming existing assets plus $30k a year invested in VTSAX at 7% annual growth. We’ve since invested more like $45k-$50k a year and the market has generally been returning better than 7%. So anything over projections gets treated almost as play money: I exchange it into bonds whenever it feels like stocks are high and move back into stocks when they seem low. The base-level projected balances remain invested fully in VTSAX.
I feel more confident knowing that a mistake or two with the surplus probably won’t impact our overall plan. Worst case, we still retire on time; best case, my fumbling strategy and the whims of the market get us out of the rat race years earlier and/or significantly wealthier.
Yes you are right. I learned my lessons as well. What you need to do during market sell down is just staying the course!Rebalance your portfolio n keep buying!
Some lessons you need to learn the hard way. It’s also good to invest as young as possible. You learn when you don’t have much money.
Xrayvsn’s “strategic rebalancing” has been my play as well. I swapped our 15% bonds position entirely into VTSAX on March 11 and then got back in last week; made a nice 11% on those dollars without hardly trying. It’s like magic.
That said, my wife and I both have reasonably secure jobs (hers more so, and she makes half again what I do) so we’re in a very fortunate position to just keep buying cheap. We’re determinedly channeling energy and money and attention into political candidates and policies that support folks who aren’t so fortunate.
That’s a gutsy move. I think you have to go through a crash or two to do that. It’s very hard to buy when the stock market is dropping. Of course, secure employment helps tremendously too.
My retirement contributions are set on autopilot so that it maxes out each year.
I otherwise have not been putting money into the stock market since 2017 because I had been funneling it into real estate.
I did, however, still take advantage of the March dip by doing strategic rebalancing and will continue to do so in future.
I did some strategic rebalancing too. That’s another reason to have some bonds and cash.
Great advice in this post.
Personally, I doubled down on buying stocks from March until today. Left as little cash reserves as possible. I’m just a bit bummed I didn’t get in more and at a faster rate.
We just might get another chance, who knows.
Cheers!
It’s pretty amazing how fast the market recovered. I don’t know if this recovery will last, though. We might have another chance to buy at a discount again.
Yep, great message Joe and glad yo learned from your mistake. To me investing in tax-sheltered retirement accounts (if available) should be treated like breathing. Automatic, no questions asked. Since I’m still only semi-retired and part time I still have a 401k and have been contributing the max every paycheck through this whole pandemic.
That’s the easiest way to invest. Everyone should have their 401k contributions on autopilot.
Good advice Joe, and the best part is it’s true! The vast majority of my own wealth was built because I had the cash flow to keep investing during the last three recessions (2001, 2009, and now in 2020).
That’s really the name of the game — Be greedy when others are fearful and be fearful when others are greedy.
We’ve still got a ways to go before this latest recession is done, but the stench of fear seems to have already left the building. 😉
I don’t understand the stock market at all. The economy is in shamble, but stocks are going up like nothing happened.
I heard that it could take 5 years to recover economically. It’s scary on main street.
Great advice Joe. I was not around during the 2000 crash but remember the craziness of 2008. I actually never bothered to tinker with my 401K whihc was great. But I was buying options on banks and doing a lot of trading which was quite stressful. Had a margin call from my broker when Bear Stearns was crashing. Lots of lessons learnt.
That’s great in 2008. Are you still buying options and using margin? That’s too stressful for me.
No more margin. Just options trading now. I have set rules. Also I’ve become more conservative. Combination of having to preserve wealth and also a decade older so value my free time more.
Great message. I can’t believe the market recovered so quickly, but I think there’s more pain ahead in remaining quarters of the year. I put more and more money into the market during the March drop and am waiting to put more money in when it drops again, but in the meantime, and dollar cost averaging and buying on a regular basis to keep myself steady.
Great job! Every investor should do this.
Yes, you are right! I always tell my blog readers that you should be happy when the market crashes because you get more shares with the same amount of money! The only caveat to this you have to hold mixture of stock/bond ETFs and index funds and NOT individual stocks.
If you keep on buying individual stock while the price is dropping, you would never know it would go bankrupt or not!
Also, this is great when you’re young. If you’re older, then you need to be a lot more conservative because you don’t have much income after retirement.
Good point about individual stock too. Thank you!