Why You Shouldn’t Fear a Crash in the Middle of Your Investing Journey

When it comes to investing, I got lucky.

I was in college during the financial crisis. I missed that horrifying 38% dip in 2008. My investing career started in 2010, right at the beginning of an outrageous bull market that’s still stampeding forward today.

That’s the dream right? To start investing right after the big crash and ride the upswing?

Not so fast. Like always, I wanted to run the numbers. It turns out, there are ways in which it would have been better if I had gone through the horror of 2008.

Let’s break it down.

What Would Have Happened If You Started Investing in 2005?

Let’s assume the following:

• You started investing in an index fund tracking the S&P 500 in January 2005
• You contributed about $400 every two weeks (roughly $10k a year)
• For simplicity, we’ll ignore dividends (which help) and fees (which hurt)

Here’s what would have happened to your portfolio up through today (May 2021):

Contributions	Earnings	Portfolio Value
$163,889	$260,818	$424,707

Not too shabby. You’re well on your way to becoming a millionaire.

This chart is a “stacked area chart.” The blue shaded area represents the portion of your portfolio made up of your own contributions over time. Stacked on top is your earnings, shaded green. Because earnings can be negative when the market drops, it sometimes dips below the blue.

You can think of the solid green line as your portfolio balance. When the green line is under the blue line, the value of your portfolio is less than the sum of your contributions to that point.

What Happened to 2008?

If your observant, you might be asking yourself why the 2008 meltdown didn’t look like such a big deal on that chart. For instance, it looks much scarier if we show the daily closing price of the S&P 500 over the same time period:

And if I want to make it look really scary, I can cut off the bull market of the 2010’s and just show you what happened between 2005 and the bottom of the market in early 2009:

Well, there are two important things happening here.

First of all, farther removed you are from an even, the less significant it looks. Compound interest takes over and the scale gets big enough to render your crash a blip. That’s why 2008 looks so much more severe in the last image I showed.

But the other reason is that regular contributions smooth out the ride. If you were making regular investments in 2008, negative earnings were putting downward pressure on your portfolio, but your contributions were counteracting this effect.

This buffering effect of contributions is most powerful when your portfolio is smallest. A 38% drop on a balance of $10,000 isn’t going to sink your portfolio when a fresh $10k will be pumped in this year.

What Would Have Happened If You Started in 2010?

For this chart I’ll keep the same scale on both axes, but we’ll start investing in January 2010:

Contributions	Earnings	Portfolio Value
$113,889	$136,545	$250,433

The first thing you’ll notice is that almost half our money is gone! What gives?

Well, the first problem is that we’ve invested $50,000 less because we started five years later ($163,889 vs $113,889). Let’s run the numbers again starting in 2005 but stopping once we hit $113,889 invested.

Starting in 2005, Stopping in 2016

Contributions	Earnings	Portfolio Value
$113,889	$235,334	$349,223

Look at that, the earnings alone are nearly as much as the total portfolio if you had started in 2010. And you invested the same amount.

Those five extra years of compounding made a huge difference, even though total contributions are the same.

The financial crash hurt, but it didn’t take us down to zero.

At the bottom of the market on 3/9/2009, your $22,833 portfolio balance was well less than the $42k of contributions you had made up to that point. But it was still $22,833 exposed to a lengthy bull market. You can’t time the market, but by investing regularly you had capital in place to benefit from a legendary bull market run.

One Final Comparison

Let’s come up with a situation where investing after the crash comes out on top. All we have to do is cut off the last five years. Our early investing situation is $10,000 a year for a little over 10 years from 2005 to 2016. Let’s just stop it there and not let it grow any more.

Contributions	Earnings	Portfolio Value
$113,889	$58,091	$171,980

Your initial intuition that investing after a crash is better was correct all along, but only if we control for the contributions and the time.

That might seem like the most fair comparison, but is it the best real world comparison?

The time between 2016 and now has come and gone. No matter when you started investing, you live in the present moment. As long as you didn’t panic and sell, you’d be ahead if you started investing early—even if you had to invest through a crash.

When Crashes Actually Hurt

In a previous post, we looked at what happens if you start investing just before a stock market crash. Short answer: If you stay the course you’ll probably be fine in the long run.

In this post we’ve seen that you can do just fine if the market crashes a few years in to your investing journey.

So are marker crashes something you should ever worry about?

Yes.

A general principle to keep in mind is that the more money you have invested, the more crashes hurt.

A stock market crash when you’re 30 and have been investing for eight years isn’t a huge problem. In fact, it’s probably an opportunity to invest at lower prices. A market crash when you’re 60 and have been investing for nearly 40 years can be pretty brutal.

Crashes also hurt more when you’re taking money out of the market instead of putting money in.

Think of it this way: If you withdraw $40,000 this year in your retirement just after a crash, you’re selling off shares that used to be worth much more. A market crash while you’re investing is just a “paper loss.” You don’t actually lose money until you’re forced to sell.

But it’s actually a double whammy. Not only does selling lock in the loss, but that $40,000 no longer has the opportunity to catch the recovery. Your portfolio value is being simultaneously eroded by withdrawals and market losses.

Protecting Yourself From Market Volatility

Market crashes hurt most when your portfolio is large and when you are withdrawing instead of investing. This is why later in your investment career, Asset Allocation becomes so important. The stock market provides fantastic returns, but it’s just too volatile to house all your money

By putting part of your portfolio in one or more different asset classes (like bonds), you protect part of your money from the large losses of market crashes. You are also able to force yourself into “buy low/sell high” transactions through periodic rebalancing.

This is why you’ll hear people say you can invest aggressively when you’re young. Young investors have three critical advantages:

• Time to recover from steep losses
• Not needing to sell shares means they won’t lock in their losses
• Regular contributions smooth the ride and keep their portfolio trending up

As these advantages erode, the market becomes too risky and unpredictable. The best solution to protect yourself is to diversify across asset classes.

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Related Post: Asset Allocation The Simple Way: How to Protect Your Wealth

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Final Thoughts

Chances are, you know the importance of investing early. It’s a no-brainer when you see the smooth charts of predictable 7% returns. But the market is volatile and when you start thinking about investing, people say to hold off because a crash or correction is coming.

Well, I have news for you: A crash or correction is always coming.

Even if it comes, you’ll still be fine in the long run if you stay the course. Keep investing regularly as you build wealth, transition to a more diversified asset allocation when you need to start protecting your wealth.

When the market happens, just remember what it will look like in hindsight of you stay the course:

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Related Post: What Happens If You Invest Just Before a Stock Market Crash?

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