- The lower stocks go, the richer you will be. Sound crazy? I’ll show you how it works.
- There is no trick, you just do what you would do anyway and end up richer even if you have $500k in stocks now.
- I’ll end on a personal note about how I’ve made most of my investment returns after terrible market crashes.
A real investor is one who is happy when stock prices fall. Let me ask you a few questions borrowed from Buffett:
A short quiz: If you plan to eat hamburgers throughout your life and are not a cattle producer, should you wish for higher or lower prices for beef?
Likewise, if you are going to buy a car from time to time but are not an auto manufacturer, should you prefer higher or lower car prices?
These questions, of course, answer themselves.
But now for the final exam: If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period?
The answer is perhaps counterintuitive considering all the headlines about how bad this week’s market decline was, but if you plan on adding money to your portfolio in the future —and I know the majority of my readers are—then you should be happen when stock prices fall and sad when they rise.
Just think of it as shopping. We’re happy when something is discounted and we usually brag about the discount or about how we negotiated an even lower price. It just goes to show how completely illogical it is when people are happy when the stock market goes up. We should rejoice when stock markets decline and be unhappy when they rise.
Still not convinced? I’ll show you how this works with a few examples. But before I do, here’s another useful quote from Buffett:
“So smile when you read a headline that says ‘Investors lose as market falls.’ Edit it in your mind to ‘Disinvestors lose as market falls — but investors gain.’ Though writers often forget this truism, there is a buyer for every seller and what hurts one necessarily helps the other. (As they say in golf matches: ‘Every putt makes someone happy.’)”
A Few Examples That Show Why Lower Prices Are Better
I’ll assume that an investor puts $5,500 in his 401(k) each year and buys the S&P 500.
Let’s say the S&P 500 is at 2,650 points and delivers a 4% yearly return over the next 10 years. I’ll exclude dividends to keep the calculations simple. The current price to earnings ratio is 25, so that is where the yield comes from.
Now I’ll create 3 scenarios. The first is the scenarios most investors wish for, one where the S&P 500 steadily increases by 4% per year over the next 10 years. In the second scenario, I’ll assume that the S&P 500 remains flat over the next 10 years. In the third scenario, I’ll assume it will fall 70% in 2018 and grow at the earnings yield for the next 9 years.
Which scenario do you think will be the best? The logical answer is the first scenario because the S&P 500 would be at its highest in 10 years, but that isn’t the correct answer. Let’s see.
Scenario 1 – S&P 500 Grows 4% Per Year
If the S&P 500 grows linearly for the next 10 years at a yearly rate of 4%, in 2027, it would be at 3,771 points. Now if we assume you invest your $5,500 per year each year, after 10 years you will have accumulated 17.5 shares of the S&P 500. 17.5 shares of the S&P 500 would give you a wealth of $66,033, which isn’t bad for having invested $55,000 over 10 years.
Assuming the same dividend as what the S&P 500 currently offers, your yearly dividend would be $839 per year.
Scenario 2 – S&P 500 Remains Flat
If the S&P 500 remains flat for the next 10 years, in 2027, it would still be at 2,650 and the value of your $55,000 that you invested would still be the same. However, you would have accumulated 20.75 shares of the S&P 500 and your yearly dividend would be $995.
Scenario 3 – The S&P 500 Crashes 70% This Year
In the third scenario, let’s assume the S&P 500 crashes 70% to a level of 795 points which would imply a price to earnings ratio of 7.42, or an earnings yield of 13.47%. After that, the S&P 500 increases 13.7% per year which would lead it to a level of 2,220 points in 2027.
However, if you keep investing your money, you would find yourself with 41.41 shares of the S&P 500 for a value of $91,955, and a dividend of $1,986 per year. So, even if the S&P 500 is lower after 10 years compared to the previous two scenarios, with lower stock prices you would be much better off. Keep this in mind next time stock prices fall.
What If You Have $500k In Your Portfolio Now?
Many would be pretty nervous to see the S&P 500 lose 70% as it would lead to a portfolio loss of $350,000. however, if your investment horizon is in 10 years, it would be good even for you.
The dividend on your $500,000 would be $9,050 at the moment so in addition to the above $5,500, the total yearly investment would be $14,100.
In scenario 1, where the S&P 500 continually grows by 4%, you would end up with 233 shares of the S&P 500 and a value of $880,000 and with a dividend of $11,000 per year.
In scenario 3, the value of the portfolio would be lower, at $655,000 but the dividend yield would be $14,000. So from a passive income perspective, a crash would be welcome.
If you extend the scenario to 20 years, the stock market crash perspective would be even more favorable to investors.
I was lucky to start investing in 2002. I invested in 3 stocks that had relatively low price to earnings ratios and were growing. Things were extremely cheap in 2002. By 2006, I found myself with one 10-bagger, one 5-bagger, and one stock that went nowhere. The cumulative return was one where I quintupled my money. In 2008, I lost some money but I invested heavily again from 2009 to 2011. I again quintupled my money up to 2015.
If the stock market had reached permanently high plateaus in 2000, I would now be worth far less and would lack the memory of myriad of amazing experiences I’ve lived thanks to spending the money I’ve made in the stock market. I wish the same for you, thus I wish you a stock market crash.