Do You Wish Stocks Would Crash? That Might Not Be Crazy

Forty-one-year-old Eva Barnes and thirty-four-year-old Heidi Middleton were camping in the mountains of Arizona. As the evening temperature dropped, they built a fire and poured a couple of drinks.

“Heidi, how long have you been investing in the stock market?” Eva asked.

“A few years. I’ve been investing for my children’s education. But I’ve only just started to invest for my retirement. How about you? How long have you been investing?”

“I started in my early 30s,” Eva replied. “But I was only investing about 5 percent of my income. When I was 38, I ramped that up to about 35 percent of my gross annual income. But I’ve only been doing that for the past three years, so I don’t have as much money as I wish I did.”

At that point, a ghostly haze drifted behind the campfire. “What is that thing?” asked Eva. Neither woman was afraid (they credit the drinks). But they grew increasingly curious when it took a hazy, human-like shape. Its eyes were bright blue and it wore a dark, ragged cloak.

It then spoke. 

“You are investing in the stock market.”

“That’s right,” said Heidi, as she put her hand over a rock. She figured she could nail it if the creature came closer.

“Would you like to see stocks crash this year?” sneered the specter.

“What kind of question is that? Eva asked. Of course, we don’t want stocks to crash. We’re investing money.”

The creature then waved a bony, claw-like hand and a large image appeared over their tents. It represented two scenarios. In the first scenario, stocks would fall this year. Stocks would then fall next year.  And they would fall even further the year after that. Over a proposed twenty-year period, stocks would average a compound annual return of 6.3 percent.

Scenario 2 was beside it. In scenario 2, stocks would rise 35.79 percent this year.  They would rise another 20.96 percent next year. And they would soar a further 30.99 percent the year after that. Over that twenty-year period, stocks would average a compound annual return of 9.41 percent.

“Choose!” boomed the creature.

Eva took another swig of her drink and yelled, “Are you freaking crazy? Neither of us would pick that first scenario! The stock market would fall for three straight years and then average a measly 6.3 percent. Why would anyone want that?”

“Choose!!!” The creature boomed again.

“I’m going to humor this creep,” said Heidi. “I choose Scenario 1…not because I think it’s better…it obviously isn’t. But you don’t have the power to make any of these scenarios come true anyway.”

The scepter then floated towards Eva. “Choose!” it screamed. 

“OK,” Eva said.  “I’ll choose Scenario 2.”

The creature gave a smile and disappeared.

You won’t likely be accosted by an apparition and asked to choose between two stock market scenarios. But if that occurred and you’re a relatively new investor, pick Scenario 1.

Most new investors, unfortunately, think rising stocks are good for them and falling stocks are bad. They believe a period of strong market returns are good for them, and periods of weak returns are bad. That’s backward thinking.

Warren Buffett says:

“If you will be a net saver over the next five years, should you hope for a higher or lower stock market during that time 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…This reaction makes no sense. Only those who will be sellers of equities [stock market investments] in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices.”

No, history’s greatest stock market investor hasn’t lost his marbles. When stock prices fall, purchasers are able to pay lower prices for their stock market units.  And if they reinvest their dividends, those dividends can also buy a higher number of stock market units. Then when stocks eventually rise again, such a portfolio’s market value shoots up from a catapult.

That’s why investment advisor and author, William Bernstein says, “Young people should pray for a long, awful [down] market.”

Scenarios 1 and 2 represented real times in history. Below, you can see their actual time frames.

*Source for US stock returns: portfoliovisualizer.com

Scenario 1 might look ugly. But it would have earned more money for a young investor. Assume a young person had $10,000 at the beginning of each period, and they invested $1000 a month for the next 20 years.

After 20 years, the investor in Scenario 1 would have had more money. It’s true that the stock market earned a lower average return in Scenario 1, but that’s only based on a measurement called  Time-Weighted Return. In other words, it represents how a lump sum would have grown. However, most people add money to the markets over time. Their actual returns are measured by something called Money-Weighted Return.

Note the differences below, assuming the investors each began with $10,000 and invested a further $1000 a month. After twenty years, the investor in Scenario 1 would have ended up with $737,362. The investor in Scenario 2 would have $653,959. In other words, despite the fact that the markets earned a lower overall return in Scenario 1, the investor in this example would have ended up with $83,403 more money.   

Source: portfoliovisualizer.com

I’m still adding money to my investment portfolio. I’m about 15 years away from traditional retirement age. That’s why when stocks rise, I shrug my shoulders and keep adding money. But when stocks drop, I celebrate. If you’ll be adding money to the markets for the next several years, you probably should too.

Note: Eva and Heidi are real people.  But they didn’t really meet a ghost in the desert.  Although, they probably wish they did.

Andrew Hallam is a Digital Nomad. He’s the author of the bestseller Millionaire Teacher and Millionaire Expat: How To Build Wealth Living Overseas

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