The stock market, the greatest generator of long term wealth, never gets there in a straight upward line. It is always a series of constant daily, weekly, monthly, annual ups and downs, sometimes small; sometimes quite large. 20-30% pullbacks (normally over weeks or months) are not unusual and sometimes 50% pullbacks occur but they are rare and normally occur during deep Recessions. When any of them occur, did you lose money?
Answer - it depends. Most people compare their highest stock portfolio valuation to what the stocks are worth after a downturn and consequently think that they have lost money. That's not necessarily true. For example, let's take the worst case scenario – a 50% decline in the stock market for a portfolio that was worth $100,000 at its height, but is now worth $50,000.
Scenario 1 – You invested the entire $100,000 at the peak of the stock market and now it is worth $50,000. Yes, if you cash it out, you definitely lost $50,000. However, if you leave it there for decades, and the stock market follows its historical precedents, then you likely will recover that $50,000 in 7 years or less, and go on to double and redouble that initial $100,000 investment.
Scenario 2 – You have been investing regularly for years and have actually spent $30,000 purchasing your current investments over time. Therefore, when your appreciated value of $100,000 at its peak high, drops down to $50,000, you would be wrong to say that you suffered a 50% loss. In actuality, you have a $20,000 gain over your $30,000 cumulative investments totals for a percentage gain of 67%. Again, if you do not sell it and just hold onto it for decades to come, you will likely again reach $100,000 and then double and re-double that amount over decades.
In order not to be forced to sell during a downturn of the stock market, the money that you have invested should not be money that you are going to need a short time later (whether that be a few months later or a few years later). Keep that money apart from your stock market investments and instead in a safe short term, liquid investment such as money market or short term CDs “laddered” to keep each CD reaching its term limits on a regular cyclical basis while the others are still not at maturity. For example, 6 one year CDs with one CD reaching maturity every two months. Gains will be tiny but safe.
Scenario 2 above is the best method of investing – in frequent small increments over a long period of time. That way when stock markets are high, the same amount of money invested then buys less shares at high prices and when the stock market is low, the same amount of money invested then buys more shares at low prices. Most people find it easiest to determine what percentage share of income they want or can afford to invest and automatically buy that same percentage each month.
What should you do if you want to use Scenario 2, but haven't in the past and now have a large amount of money available to invest? There is no perfect answer here:
If the stock market has recently crashed very substantially and hasn't yet started to recover, investing the whole amount of money available has the best chance of paying big dividends relatively soon (7 years or less).
If the market is at or close to an all time high and has been increasing nicely for 7 or more years, the stock market is at higher risk for a serious pullback. Investing the whole amount of available savings carries more risk. However, markets in the past that have reached an all time high sometimes experience hundred more all time highs over a number of years before any serious pullbacks begin. No one knows the short term future.
One possible play would be to start your investment program by investing each month your normal percentage of income that you would like/hope/can afford to permanently do in the future. To that monthly investment, also invest some of the already accumulated savings each month for say the next five years or more. So $100,000 saved would add another $1,666 invested each of the next 60 months (5 years). $60,000 saved would work out to $1,000 added investment per month. This won't make you the most gains possible, but it should earn you considerably more than not investing it at all, while also guarding against potential stock market crash short term catastrophic loss in value if the whole amount is invested in one shot.
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