Growing up I heard horror stories about the 1929 stock market crash. Devastated traders jumping from windows and fortunes lost overnight. However I felt safe due to the distance that time creates. Surely something that terrible couldn’t happen again? Boy was I naïve. Fast forward to today where we are in the midst of the coronavirus pandemic. It’s not only threatening our lives but it’s also threatening our economy. To combat the virus we’re urged to practice social distancing. While it’s impossible to distance ourselves from all economic impacts, perhaps we can find some respite by practicing market distancing.
One way to create market distance is to forestall losses. Emergency funds serve that purpose. Diversification is also way to create distance. Less exposure to riskier investments such as stocks buffers losses. The bucket strategy is yet another way to create distance from the stock market crash. If you’re unfamiliar with the bucket strategy, here’s a brief overview. A typical bucket strategy contains three time-based segments (i.e. buckets). The first bucket holds one to two years of liquid, safe investments such as cash, money market funds and savings. The second bucket contains three to five years of slightly more risky and less liquid investments such as CDs, bonds and balanced funds. The third bucket contains risky investments such as stocks. When stocks drop precipitously, the biggest losses occur in bucket three which contains money that will not be needed for many years. This creates the perception of losses happening in the future which hopefully provides a calming effect.
Too much exposure to the constant barrage of negative financial news plays into two behavioral biases – loss aversion and following the herd. Loss aversion refers to a strong preference to avoid losses vs. acquiring equivalent gains. Following the herd simply means that we’re wired to do what the majority of people are doing. We all know how hard it is to be a contrarian when the market is in turmoil but that’s what’s needed. Granted it’s impossible and undesirable to completely tune out all the calamitous news about the economy, but you can control how much you take in. The idea is to keep calm to avoid making bad investment decisions.
Another way to create market distance is to travel back in time by examining four stock market crashes. 1) The stock market fell nearly 13% on day four of the October 1929 crash. The crash was followed by the Great Depression. It took twelve years for the U.S. economy to recover. 2) On Black Monday, October 19, 1987, the market suffered the worst ever one day decline (22.6%) ever. It took stocks two years to surpass the close of the last trading session before Black Monday. 3) The dot com bubble deflated over the course of two years – 1999 to 2000. The tech heavy NASDAQ fell from 5,000 in early 2001 to 1,000 by 2002. The NASDAQ next topped 5,000 in April 2015. 4) In the Great Recession stock market crash, the market fell from 14,198 in October 2007 to 6,469 in March 2009. It took about eight years for prices to recover.
This Too Shall Pass
The underlying lessons are that unfortunately stock market crashes occur. They are disruptive and take time to recover from. The last point is worth repeating. It’s not a matter of if we will recover, but how long it will take. But we can’t expect things to go back to the way they were. Just like life changed after 9/11, things will be different going forward. It’s up to us to make them better. In the meantime, it doesn’t hurt to practice market distancing.
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