Why Millions Of Americans Should Hope For A Stock Market Crash
August 10, 2015

Why Millions Of Americans Should Hope For A Stock Market Crash

I hope stocks fall.  That might sound pretty strange.  But not everybody should be cheering for the same team. In fact, about 125 million Americans should wish for stocks to stagnate, dip or downright crash. That’s roughly the population between the ages of 25 and 55.  A smaller number of people (about 76 million) should prefer stocks to rise.  That’s the population of Americans above the age of 55.

The media, however, seems to ignore this dichotomy. Playing to primal fear and greed, most news reports imply that bull markets are always good; bear markets are bad. But most investors, between 25 and 55, should turn that notion on its head. Those working and investing for at least the next five years should smile if the markets fall. Warren Buffett agrees.  In Berkshire Hathaway’s 1997 letter to shareholders, he gave a little lesson.

Buffett asked if hamburger eaters should hope to see a rising cost in beef.  He asked if those buying a car from time to time should be happy if cars get more expensive.  Unless you’re a producer of cattle or cars, the answers should be no.  Then he adds a final question.

“If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period? Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall. In effect, they rejoice because prices have risen for the ‘hamburgers’ they will soon be buying. This reaction makes no sense... Prospective purchasers should much prefer sinking prices.”

William Bernstein, the former neurologist turned financial advisor, says investors in their 20s or early 30s should  “pray for a long, awful [bear] market.” He wrote, If You Can, a short ebook about investing for Millennials.  In it, he explains that when stocks drop, investors pay less for a greater number of shares.  By dollar cost averaging, such investors can stockpile assets.  When the markets eventually recover, those asset values soar.  

It’s different for retirees or those knocking on retirement’s door. After all, during retirement, they’ll be selling investment shares each year.  Back tested studies show that retirees should be able to withdraw a real 4 percent from their portfolios annually.  If the stock and bond markets behave, they shouldn’t run out of money.

There’s a difference between a 4 percent withdrawal rate and a real 4 percent withdrawal rate. The real part allows an adjustment for the rising cost of living. For example, someone with a $100,000 portfolio could withdraw $4000 during the first year of retirement.  That’s 4 percent of $100,000.  In the years that follow, retirees could withdraw slightly more to cover the rising cost of living.  Here’s how a retiree’s first four years of withdrawals might look, with inflation adjustments set at 3.5 percent per year.

$100,000 Portfolio

Real 4% Withdrawal—Assuming 3.5 percent inflation

Years Into Retirement Annual Withdrawal Amount
1 $4000
2 $4,140
3 $4,284
4 $4,434

If stocks don’t rise, however, retirees could flounder if they live a long time.

The S&P 500 has averaged a compounding return of about 22 percent per year since the market’s low point in 2009.  That’s a 245 percent overall gain to July 24th, 2015.  Robert Shiller says stocks are now expensive. He developed a PE ratio that measures a stock’s price, relative to a company’s cyclical business earnings.  It’s called a cyclically adjusted price-to-earnings ratio (CAPE). It compares stock prices with ten years of real earnings.

Between 1881 and 2013, Shiller found that the average U.S. market CAPE level was 16.5.  Historically, when the CAPE level was higher than 24, stocks did poorly in the decade ahead.  For the U.S. market, that level currently sits at about 27.  When stocks are valued at 27 times average earnings, the decade that follows sees stock returns average about 2.5 percent per year.   

Such future returns, for retirees, would be like pedaling into a wind. But retirees who invested for much of the past 40 years have already enjoyed some tempest strength tailwinds. Vanguard introduced its S&P 500 index nearly thirty-nine years ago.  It averaged a compounding return of about 11.1 percent. That means if $100 were invested each month, starting at the fund’s 1976 inception, it would have grown to more than $716,000 by July 24, 2015.   In other words, by investing a total of $46,600 between September 1976 and July 2015, investors would have close to three quarters of a million dollars.

When that generation’s children retire, Social Security payments could be a lot less generous. Almost certainly, stocks won’t average 11 percent over the next 40 years.  That’s why younger Americans need a stronger start.  A stock market drop, today, would help.

Nobody knows, however, where stocks are headed.  We just know one thing for sure.  No matter what happens, one generation will benefit.  The other gets stuck with the bill.

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This article contains the opinions of the author but not necessarily the opinions of AssetBuilder Inc. The opinion of the author is subject to change without notice. All materials presented are compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. This article is distributed for educational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, or service.

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