This Is Why A Market Crash Is Good For You

September 22, 2017

This Is Why A Market Crash Is Good For You

  • It might sound counterintuitive, but high stock prices aren’t that great for the majority of investors.
  • If you take the perspective that looks at long term returns and actual business ownership, your future income would be much higher now if the S&P 500 had stayed at 1,000 points for the past 10 years.
  • Don’t think stock markets only go up, look to Japan to be reminded of that.

Introduction

Everybody is so afraid of a stock market crash and here I am talking about how it can be good for you.

As much as it sounds counterintuitive, a high stock market isn’t good for long term investors. The ultimate goal every investor should have is to accumulate as much ownership as possible, not to gain temporary value.

We all have seen stock market values, currency values, and bond values, evaporate like drops of rain on a summer day. Therefore, the goal is to own as much of a business as you can own, not to have a large numerical portfolio without it being backed by actual business value.

I’ll discuss two perspectives that show why lower stock prices would be much better for you.

We Mostly Invest Over Time

Most people who invest work and invest a part of their earnings into the stock market every month in order to save for retirement or other investing goals.

If you invest $1,000 per month, or $12,000 per year, or you simply put $5,500 in your IRA account or you have a pension fund that does it for you, you are adding to your nest egg monthly which is what I think most investors do before retirement. Now, as the length of time when we add funds into our portfolio is usually 40 years, an elevated stock market isn’t the best situation. I’ll explain why.

Investing Over Time & High Valuations

Using the example of Berkshire Hathaway (NYSE: BRK.A, BRK.B), I’ll explain why it would be better for the majority of us for the S&P 500 to be at 1,000 points, or where it was at the beginning of 2010.

If you had invested $12,000 per year in BRK.B since January 1, 2010, at the beginning of this year, you would now have had a portfolio of 963 shares with a value of $176,238.

Now let’s imagine that the stock market had remained flat since 2010, thus at 1,000 points. If you had invested the same amount, you would now have 1,454 shares and the total value would be what you had paid, or $96,000.


Figure 1: Comparison of continual investments in BRK.B with a growing market and a flat market. Source: Author’s data.

Now you’d probably say that it’s always better to have $176,000 rather than $96,000, but if the stock market falls 50% in the next bear market, which is highly probable, your $176,000 portfolio would quickly become $88,000.

Looking at things from the perspective of being an owner of a business versus looking at the number Mr. Market attaches to your portfolio will make you think about investing in a different way. Let’s see how this all works out when dividends are included.

Dividend Reinvesting & Stock Prices

One of my favorite stocks to use as an example is the pharmaceutical giant Pfizer (NYSE: PFE).

PFE’s revenue in 2007 was $48 billion, earnings per share was $1.17, and the book value was $9.6. Ten years later, the revenue is now at $52 billion, earnings were at $1.17 for 2016, and the current book value is at $9.81. So the fundamentals have been stable while the stock price has been as volatile as the stock market.


Figure 2: PFE’s stock price in the last 10 years. Source: Yahoo Finance.



By applying the same example as with BRK.B where we invested $12,000 per year, reinvesting the dividends since 2010, the current PFE portfolio would be at 4,463 shares, or $158.347.


Figure 3: Investing $12,000 per year in PFE and reinvesting the dividends. Source: Author’s data.

The current dividend from the 4,463 shares would be $5,712 per year.

Now let’s see how this would look with PFE’s stock price remaining at 2010 levels.


Figure 4: Investing $12,000 per year in PFE with stock prices flat. Source: Author’s data.

In this scenario, the portfolio would consist of 6,421 shares with a dividend yield of $8,218 which is 43% higher than what the reality is today.

The value of the portfolio would, however, be lower at $117,000, but there is a big difference between having to sell stock to fund your retirement income, for example, or to just enjoy a higher dividend.

Be Happy When The Next Crash Comes

The examples above illustrate how long-term return portfolios would consist of much more equity if stock prices were lower for a longer period of time. A high stock market makes everything look good for a while, but the fundamentals—your actual dividends when you retire and thus the income you are supposed to live off of—will be much lower over 10 or 20 years.

If you think the stock market can only go higher over time and that you will be able to sell part of your portfolio to finance your future needs, you might want to take a look at the Japanese stock market chart from the last 30 years.

Those who thought they would be able to sell part of their portfolio were very disappointed when the actual sale value was just a fraction of what is was back in 1989.


Figure 5: Nikkei stock market chart. Source: Yahoo Finance.



The main point of this article isn’t to discourage you from owning stocks at this point in time even though valuations are high, but rather to lead you toward an emotionless attitude with investing.

If the market goes higher, great. If it falls, it will also end up well because you can buy more of the same thing for lower prices. Forget about short term fluctuations, invest continually and you’ll end up well-off over time.

If you want to increase your investment returns and wealth further, you have to seek out investments that have a higher earnings yield and offer a margin of safety, as is now the case in Russia. Keep reading Investiv Daily as we’re always discussing market beating investing strategies.