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February 11, 2016

# Why This NYU Business Student Wants Stocks To Crash

Oscar Adelman’s grandparents always wanted their grandson to be an investor. When he was born, they bought him shares of Home Depot stock. By the time he was 12 years old, Oscar was reading The Wall Street Journal. Today, the 20-year old studies at NYU’s Stern School of Business. He watches the markets daily. In January, U.S. stocks fell almost 8 percent. Oscar is starting to salivate. A good, solid crash is what he wants.

No, he hasn’t leveraged a family fortune to gamble against the market. He’s a long-term investor. He also knows something that most people don’t. Market crashes are Christmas presents for every young investor. Investment author William Bernstein says, “If you’re a twenty-something just beginning to save, then get down on your knees and pray for the [next] Crash….”

As I write, Vanguard’s Total Stock Market Index ETF (VTI) has a dividend yield of 1.99 percent. This means that investors earn nearly 2 cents in annual dividends for every dollar that’s invested in the index. But if stocks fell by 50 percent, the dividend yield would double to 3.98 percent. If stocks fell 75 percent, the dividend yield would triple to 7.96 percent, assuming the dividend payout was unchanged.. But investors who add money to the stock market would earn three times the dividends for each dollar invested.

As a student of the market, Adelman says, “Most people don’t know that the greatest stock market gains, long-term, don’t come from the stock market going up. They come from reinvested dividends.” The Coca Cola Company illustrated this point in 2012. If \$40 were invested in Coca Cola in 1919, it would have grown to a value of \$341,545 by 2012. Reinvest the dividends and that \$40 investment would have grown to \$9.8 million.

#### Coca Cola Share Gains, 1919-2012 With And Without Reinvested Dividends

In his book, Rational Expectations: Asset Allocation For Investing Adults, Bernstein says that stock market risk is relative. Yes, older people might fear falling prices. But if a young person has money in the markets, and they plan to keep investing, a crash could make them rich.

Bernstein’s book introduces us to the fictitious character, Sam Sixty-Five. Sam builds a portfolio of stocks. He retires in January 1929, right before history’s biggest market crash. His timing couldn’t have been worse. Stocks fell 89 percent to July 8, 1932. On July 9th, they began to recover. But they fell almost 50 percent between 1937 and 1938. U.S. stocks didn’t reach their pre-1929 level until 1954.

If Sam had kept his head, however, he might have been fine. Many studies show that our investments have strong odds of lasting the duration of our retirements if we sell an inflation adjusted 4 percent or less per year. If Sam had done so, continuing to withdraw a similar amount (in dollar terms) while adjusting withdrawals slightly to cover the changes in annual inflation, his money would have lasted until 1950. He would have been 86 years old. If, however, he had withdrawn an inflation adjusted 3.5 percent per year, his money would have lasted until he was at least 95.

It would have been gut-wrenching to retire in 1929. But Bernstein shows that a responsible withdrawal rate (3.5 percent, in this case) would have helped investors keep their shirts.

Retirees have a right to fear market crashes. But smart, young investors like Oscar Adelman love them. Bernstein’s book introduces us to another unflappable character, Ted Twenty-five. Ted begins to invest 20 percent of his \$6,000 salary into stocks in January 1929. Even after the markets crash, he keeps adding money. His portfolio shows some decent growth by the time he’s 33 years old. But then stocks crash again. They fall almost 50 percent during the 1937-1938 stock market crash. Ted smiles. Stocks are on sale. Dividend yields increased. Ted keeps adding money.

After 30 years of investing, Ted would have added \$36,000 to U.S. stocks. “By the time he retired in December 1958,” writes Bernstein, “Ted had accumulated \$335,179.” That would have given him the purchasing power of \$2,707,000 today. He would have gone through two massive stock market crashes. But they would have juiced his returns. Ted would have earned a compound annual return of 12.16 percent per year.

Ted would have paid lower prices for his stocks, as the markets fell. Dividend payouts dropped, as many companies struggled. But dividend yields increased because stocks fell far further than dividend payouts did.

Reinvesting those dividends, and continuing to add money each month, would have made Ted Twenty-five a fairly rich man.

“Most young people think rising stocks are good for them,” says Oscar Adelman. “But crashing markets are better. U.S. stocks have fallen just 7 percent this year [to January 27]. My generation needs to hope that they keep falling.”

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