Molly Snow is a 31-year old nurse and mother of two young children. She has $5000 in a portfolio of ETFs, and she says she would be happy to see stocks crash.
Such thinking among millennials is gaining steam. Andrew Goldie is a 35-year old teacher working at a US Department of Defense school in Germany. Originally from Ohio, this music enthusiast has a combined $170,000 of index funds in his IRA and 401(k). And he says he wouldn’t mind seeing his portfolio drop below $100,000 this year. “I know that I have a long time horizon and would benefit from being able to purchase stocks on sale,” he says.
Experts attempting to estimate the future of US stocks warn that returns won’t be great. In part, that’s because the price-to-earnings ratio for the average stock is far higher than the historical norm.
Yet if that happens, it might not hurt millennials. In fact, if stocks crashed now, investors like Molly Snow and Andrew Goldie would be dancing in the streets.
After all, how the stock market performs and how people perform in the stock market are often two different things.
For example, assume Molly Snow met a fortune-teller who said, “Molly, my crystal ball says stocks will crash 40 percent over the next few years and they won’t make a profit over the next ten years.” Molly’s portfolio includes 80 percent stocks and 20 percent bonds. If stocks crashed 40 percent, Molly’s $5000 portfolio would drop to about $3,800. Now assume the fortune-teller were right. Ten years from the date of the fortune-teller’s forecast, US stocks languished.
That decade-long slump might look something like this.
When people talk about historical rates of return, or when they try to project returns for the future, they refer to something called Time-Weighted Rates of Return. The chart above shows the Time-Weighted Rate of Return for US stocks from January 2000 to January 2010. It was a negative annual return.
Now assume the stock market did something similar over the next ten years: three calendar year declines in a row, followed by a recovery and then another market crash. Assume the decade-long Time-Weighted Rate of Return (TWRR) was negative, as it was from 2000 to 2010. If Molly added $500 a month to her portfolio for the next ten years, this is what her portfolio would look like if that decade’s performance were replicated.
Molly would have started with $5000. She would have added $500 a month for ten years, making her contributions total $65,000. But over this ten-year period–a period when a lump sum investment in US stocks would have dropped about 10 percent–Molly’s portfolio would have grown to $76,460. That’s because Molly’s Money-Weighted Rate of Return (MWRR) would have been positive, despite the market’s overall loss.
A few years ago, I asked a young woman named Nathalie to tell me which scenario she would prefer.
In Scenario 1, the stock market soars for three straight years. Over 20 years, it earns a Time Weighted Rate of Return of 9.75 percent per year.
In Scenario 2, the stock market slumps for three straight years. Over 20 years, it earns a Time Weighted Rate of Return of 5.94 percent.
Nathalie said, “I would absolutely prefer Scenario 1.”
But in Scenario 2, the Money-Weighted Rate of Return (MWRR) would be better. Each scenario represents different historical 20-year returns for the S&P 500.
Scenario 1 shows the S&P 500 index’s actual 20-year returns from January 1, 1995 to December 31, 2014. Stocks soared in 1995, 1996 and 1997, gaining 37.58 percent, 22.96 percent and 33.36 percent, respectively. A lump sum investment in the S&P 500 would have earned a Time-Weighted Rate of Return (TWRR) of 9.75 percent annually over these 20 years. This was the scenario Nathalie says she would prefer.
Scenario 2 represents the actual 20-year returns of the S&P 500 from January 1, 2000 to December 31, 2019. Stocks dropped right out of the gate, losing 9.1 percent in 2000, losing 11.89 percent in 2001 and losing 22.10 percent in 2002. The S&P 500’s Time-Weighted Rate of Return (TWRR) would have been just 5.94 percent over this 20-year period. This was the scenario Nathalie didn’t like.
At first glance, Nathalie’s choice of Scenario 1 looks better. But that’s ignoring the fact that Natalie would be adding money every month.
Let’s start with Scenario 1.
Assume Nathalie had $50,000 in a portfolio of low-cost index funds in January 1995. If she had invested an additional $2000 a month into the S&P 500 from January 1995 until December 31, 2014, her money would have grown to $1,443,726 over these 20 years.
Now consider Scenario 2
Assume Nathalie had $50,000 in a portfolio of low-cost index funds in January 2000. If she added $2000 per month into the S&P 500 from January 2000 until December 31, 2019, her money would have grown to $1,544,560. That’s $100,834 more than what she would have earned with Scenario 1.
In other words, experiencing three huge calendar year losses early in her investment journey would have looked scary. But it would have boosted her returns.
Millennials like 32-year-old Matthew Laemmli are catching on fast. He began investing last year, and he’s currently adding $200 a month to a portfolio of index funds. “If the stock market were to crash and stay low for several years, that would give me the opportunity to buy low through my mid-thirties. It feels good to know I’d have a larger payoff decades down the road.”
Thirty-one year-old Afif Ghalayini says much the same thing. Afif, who works as a management and strategy consultant, says, “If I am lucky enough, a crash will happen at early stages of my journey, allowing me to reap the benefits of purchasing investments at a discount early on, and hopefully for a lengthy period of time.”
It’s true that stock market crashes are terrifying for retirees.
But as golfers say, every putt makes someone happy.
That’s why young investors should prefer falling markets.
Andrew Hallam is a Digital Nomad. He’s the author of the bestseller Millionaire Teacher and Millionaire Expat: How To Build Wealth Living Overseas