By: Mike Earl, CFP®, CPWA®
It’s not uncommon for people to talk of getting “wiped out” in a past stock market crash. Is that even possible? And if it is possible, how?
The short answer to the question has been a resounding no. Thus far in US stock market history, the major stock market indices (such as the Dow Jones Industrial Average or the S&P 500 Index) have never gone to zero. With the US stock market being near all-time highs today, any dollars invested broadly in the US stock market would have experienced tremendous growth over time – in spite of some serious downturns throughout history.
Even during the Great Depression, wherein the US stock market (as represented by the S&P 500 Index) was down more than 80% from peak to trough, any investor who remained invested in the broad market was eventually back to breakeven (though it did take many years to be made whole again!).
So what gives?
There are several potential causes that could lead someone to saying they were “wiped out” during a crash:
1) Owning a portfolio comprised of a small number of individual stocks.
Individual companies do go bankrupt, so individual stocks can see their value go to zero (or nearly zero). If you owned a portfolio filled with Enron, Kodak, Circuit City, Blockbuster, and Tower Records, then you may have been completely wiped out.
This highlights why diversification is so important. Today, there are approximately 3,486 publicly traded companies in the US. Some of those companies will cease to exist in the future. But by owning several hundred or more different company stocks, you decrease your risk of being deeply damaged by individual corporate bankruptcies.
Back during the Tech Boom of the late 1990s, there were 7,562 publicly traded companies in the US. That’s more than double the number of publicly traded companies we have today! The Nasdaq Index (comprised of many technology stocks) declined by 81% from peak to trough from late 2000 to mid-2002. Ouch.
2) Significant debt or an inflated lifestyle.
If you lose your job or become under-employed during an economic downturn, lenders don't stop asking for the monthly payment owed to them. Sometimes, people are forced to sell off their portfolio – either gradually or in big chunks – in order to make their debt payments.
Plus, a really bad stock market invariably coincides with a bad US economy. A weak economy leads to a rising unemployment rate, which leads to a rapidly declining stock market. It can be a perfect storm, wherein people withdraw large percentages of their portfolio during a falling stock market. Ultimately, they can wipe themselves out in this manner, leading them to have little or no money left in their portfolio to enjoy the inevitable rebound in the stock market.
From a lifestyle perspective, some retirees simply spend themselves out of money. If a couple is withdrawing a large percentage of their portfolio each year, they will eventually spend the money to zero. In that case, the stock market did not wipe them out; they wiped themselves out.
3) Panic selling.
Watching the stock market tumble can be unnerving. It requires enormous emotional resolve to stay invested during the deep bear markets (such as the Great Depression and the Great Recession). When people do panic and sell out, they sometimes never get invested again. Thus, they experience only the market downside and none of the subsequent upside. When money sits in cash, it experiences little growth (typically less than inflation). And when the time comes to start spending that money (for retirement or other lifestyle needs), it will be whittled down much faster due to the absence of growth.
What does this mean to you, our client?
Remember that you are a long-term investor. We know that stock market drawdowns are a regular occurrence (just like winter). So, we prepare for them emotionally – then we are less surprised when they do come. We stay the course and remember that investing is a marathon, not a sprint.
Because The Wealth Group, Austin B. Colby & Associates is independent of Raymond James, the expressed written opinions above are our own and not necessarily reflective of Raymond James’ opinions.
The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. The Dow Jones Industrial Average is an unmanaged index of 30 widely held securities. The NASDAQ Composite Index is an unmanaged index of all stocks traded on the NASDAQ system. Inclusion of these indexes is for illustrative purposes only. Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance.
Individual investor's results will vary. Past performance does not guarantee future results. Sector investments are companies engaged in business related to a specific sector and are subject to fierce competition and their products and services may be subject to rapid obsolescence. There are additional risks associated with investing in an individual sector, including limited diversification. Though it can help mitigate risk in a portfolio, diversification does not ensure a profit or guarantee against a loss. The mentioning of individual companies is for informational purposes only and is not a recommendation to buy or sell a particular security. Investing always involves risk. No investment strategy can guarantee success. Prior to making an investment decision, please consult with your financial advisor about your individual situation.