With the fear of a recession on the horizon thanks to an inverted yield curve, the stock market has begun to sell off. Due to investor psychology, the S&P 500 generally goes up like an escalator and goes down like an elevator.
If we’re long-term investors, it’s a good idea to understand how much the stock market moves a day on average. When stock market volatility spikes, we’ll feel more calm and reduce our chances of doing something irrational.
Below is a fantastic chart that shows the daily percentage movement of the S&P 500 over the last 10 years. Each dot represents one day.
As you can tell from the chart, the majority of the time, the S&P 500 moves between -1% and +1% a day. Therefore, if you are a long-term investor in the capital accumulation phase, you should consider buying more when the S&P 500 is down greater than 1%.
If you’re in capital preservation mode, you might consider selling some of your S&P 500 index position when the S&P 500 is up greater than 1%.
Of course, nobody knows the future. Trying to beat the S&P 500 over the long run through market timing is unlikely to work.
However, we’re not trying to outperform the S&P 500. What we’re trying to do is figure out how to best invest our cash flow, or larger-than-normal cash injections, during the capital accumulation phase and vice versa.
Here’s another historical average daily percent change chart for good measure.
Previous Bear Markets Performance
We’ve had 11 bear markets since 1929. A bear market is defined as a 20% or greater sell-off. Let’s look at what happened during the three most recent bear markets to see what’s possible.
August 1987 to December 1987
On October 19, 1987, the Dow fell 22.6 percent – the worst day since the Panic of 1914. By early December, the market had bottomed out and a new bull run had started. From August to December, the S&P 500 lost 33.5 percent. Thankfully, this bear market only lasted three months.
March 2000 to October 2002
The NASDAQ bubble burst on March 11, 2000. I remember sitting on the trading floor watching all my B2B and internet stocks start plummeting by 10%+ for no reason. Over the next nine months, the NASDAQ declined by 50 percent and I finally gave up hoping the dotcom mania would come back. The S&P 500 went from a high of 1,527 to a low of 777 for a 49 percent decline over 30 months.
October 2007 to March 2009
The housing collapse was the most brutal collapse for the majority of Americans alive today. Not only did the real estate market get crushed, the S&P 500 declined from a high of 1,565 on Oct 9, 2007 to a low of 682 on March 5, 2009, a 56.4 percent decline. The bear market lasted 17 months, which at the time, felt much longer.
Based on these past three bear markets, we shouldn’t be surprised to see another decline of 30% – 55% over a 3 – 30 month period. Therefore, if you are in the capital accumulation phase and are bearish, you might want to start legging in only after a 2% or 3% decline instead of just a 1% decline.
Find Your Own Investing Methodology
Personally, I like to invest in multiple tranches with each additional amount of capital earmarked towards an investment. It makes me feel better about risking my hard-earned money because I spread out my chances of buying at the top.
Feeling better might sound trivial, but if you don’t feel good about your investment methodology, you will likely under-invest or never invest. Over a 5, 10, 20+ year time horizon, your lack of investing might leave you far behind the investing class. Then you might get angry and blame the world for all your financial problems.
Here’s an example of investing in multiple tranches. Every year my wife earmarks $15,000 towards our son’s 529 plan. $15,000 is currently the maximum gift exclusion amount for 2019 without having to file a gift tax return. I can no longer contribute to his 529 plan because I superfunded it in 2017 with five years worth of contributions.
We decided to split her $15,000 into three tranches of $5,000 each. We invested $5,000 at the beginning of January and another $5,000 at the end of January because we felt the ~17.5% sell-off in 4Q2018 provided a buying opportunity. We held off on contributing the remaining $5,000 because the market kept marching higher.
With the S&P 500 down ~6% from its peak as of August 15, we are going to send in the remaining $5,000 soon. We might decide to send in $2,500 now and then wait to see if the market continues to sell off. Either way, the $15,000 will get deployed this year because another $15,000 will be ready to go next year.
The end result of investing all $15,000 in January versus breaking up the $15,000 into three or four tranches throughout the year is likely going to come out a wash. However, the important point is that our investing methodology keeps us deploying capital instead of spending the $15,000 on something frivolous.
We have an 18-22 year investment time horizon for our son’s 529 plan. As a result, for his plan, we are in the capital accumulation phase. We can afford to ride out a 2-3 year bear market.
Find Your Comfort Zone
Back in 2012, I had just left my day job of 11 years. I received a six-figure lump sum severance that June and was thinking about hoarding it. When you go from making a healthy income each year to suddenly nothing, it’s hard to get the courage to invest your valuable cash into a risk asset.
Despite my fear, I felt the worst had passed. I also felt my severance check was like winning the lottery. I almost didn’t get it because I had inadvertently e-mailed an old confidential client file to my personal e-mail address when I was clearing out all my stuff. Luckily, my old firm recognized I did so in error.
To get over my fear of investing, I talked to my personal banker to see if there was some type of instrument that provided downside protection in exchange for giving up some upside. It turns out there was.
I ended up investing my entire six-figure severance check into a Dow Jones Industrial Average structured note that provided 100% upside participation and 100% principal protection in exchange for only receiving a 0.5% dividend yield instead of a ~2% dividend yield at the time.
Without the 100% principal protection, I wouldn’t have had the courage to invest even 25% of the six-figure severance check naked long into the S&P 500. I likely would have just bought a CD earning 3.5% instead.
Below is a graphical example of a structured note that provides at least a 15% return over two years so long as the S&P 500 is not down more than 30%. If the S&P 500 is down more than 30%, you participate in the full downside. For the 30% downside protection, you have to give up collecting all dividends.
Today, my portfolio is defensive because I’m afraid of losing my gains. Everything earned after 2012 feels like funny money because I left work with enough. Now, I’ve got two people to take care of and maybe even more. The #1 rule after reaching financial independence is to never lose money.
Find an investment methodology that makes you comfortable enough to consistently invest over the long run. Make sure you also have a specific purpose for each of your investment portfolios.
Stock Market Volatility Is Part Of Investing
As long as we risk our money in stocks, we are always going to be subject to volatility. We must accept this fact.
Since 1950 the S&P 500 has seen an intra-year drawdown of 5% or worse more than ~90% of the years. ~40% of the years, the S&P 500 has fallen 5% to 10% intra-year. ~38% of the years, the S&P 500 has fallen 10% to 20% intra-year. ~16% of the years, the S&P 500 has fallen in excess of 20% intra-year.
It takes a tremendous amount of discipline to always pay attention to your cash flow and then have the confidence to invest it in the stock market. As a result, most people fail to regularly invest.
Based on my experience, the best investing methodology is to automatically invest a certain amount each month and then invest extra during large selloffs. For your retirement accounts like your 401(k), your company should provide an option to make contributions automatic.
For your after-tax investment accounts, the easiest way to invest is to go through a low-cost digital wealth manager that automatically invests your money into a risk-appropriate portfolio. Link your checking account to automatically contribute a set amount so you don’t have to think about it.
Predicting short-term performance is nearly impossible. However, over the long term, chances are high that things will turn out all right.