Presented by Fidelity
The stock market has been very unpredictable this year. At the beginning of 2020, nobody thought it would fall 35% so quickly. That was the fastest drop of this size in history. Then, the stock market came roaring back and recovered most of the loss over the last 2 months. It was the fastest recovery from a market low since the Great Depression. How did that happen? The COVID-19 pandemic is still growing and over 40 million Americans filed for an unemployment benefit since it began. To top it off, there have been protests against inequity in every state. The economy is really struggling and the Nasdaq-100 index hits a new high? That doesn’t make any sense to me. And we’re not even halfway through 2020. Who knows what the next crisis will be? The stock market could crash again or it might keep going up. What should a regular investor do in this uncertain time? Well, I don’t know what the stock market is going to do next, but I can recommend what a long term investor should do. Read on!
Learn from my mistake
Everybody makes mistakes. The important thing is to learn from them so you don’t repeat the same mistake. I started my engineering career in 1996 and my dad convinced me to save for retirement right away. That was great advice. Thanks, Dad! After a few years, I was able to max out my 401k contributions and I was on my way to financial independence.
However, I made a big mistake in 2000. The Dot Com bubble popped and the stock market crashed. My stock portfolio was losing money daily. I got scared and stopped investing in my retirement account for almost a year. When you are a new investor, it feels very difficult to invest more when your portfolio value keeps going down. At least I didn’t sell all my stocks when the market was down. That would have been disastrous.
Eventually, the stock market bottomed out and I maxed out my contributions again. Some of my friends sold their stocks and got scared off of the stock market for years. We missed out on a great investment opportunity. If we had kept investing during that crash, our investment would be worth more than 4x the money we put in. We also missed out on the retirement account tax deduction and company matching. We thought we were smart to avoid losing money, but we were wrong in the long term.
Fortunately, I learned from my mistake. The stock market crashed hard when the global financial crisis hit in 2008. That time, I didn’t flinch. My wife and I both had steady income so we felt reasonably secure. We invested all of our extra money during that recession.
I knew that during a recession is the best time to invest. You can buy more shares with the same amount of money. We were young and we wouldn’t need our retirement accounts for many years. In that situation, you should invest as much as you can in the stock market.
Don’t stop investing
2020 is no different. We are older now, and we won’t need to draw down our retirement account for at least 10 years. Like in the last recession, we kept investing when the market crashed. We also invested more when it was recovering. No matter what happens next in 2020, we will keep investing. Short term volatilities may cause the market to buck wildly this year, but this gyration won’t matter in 10 years.
In fact, the perfect time to buy more stocks is during a recession. When you invest during a recession, your purchase price is lower than normal. The stock market should recover at some point and your steadfastness will pay off. Here is a quick look at my son’s Roth IRA at Fidelity.
His portfolio balance decreased sharply in March, but it recovered very quickly to reach a new high! Last week, it dropped a little. But in 40 years, it won’t matter what happened in 2020. His investment will be worth a lot more due to compound interest.
Of course, everyone is at a different point in life. Investing more at this time might not be a good idea if you need money to pay bills immediately. Let’s look at a few scenarios.
Young investors – If you’re young and just started investing, it’s best to focus on increasing your investment. Try to max out your 401k contributions as soon as you can. Don’t worry about the stock market volatility. It won’t matter in the long term.
Experienced investors – For those of you who have been working and investing for a while, it’s crucial to figure out an asset allocation you can live with. This recent stock market crash is a good test. If you own a lot of stocks and can’t sleep at night, then you probably need to invest more conservatively. My target asset allocation is 80/20 (stock/bond) and I have been able to ride out the stock market crash without stressing out too much. Also, when the stock market crashes, you should rebalance. This will force you to buy more stocks when the price is down. That’s good for the long term.
Near retirement investors – If you’re planning to retire soon, you will need more cash cushion and probably should go with a more conservative asset allocation. Most early retirees in the FIRE community have at least one year of expense in cash. This will enable them to avoid selling stocks when the market is down. We also have a good percentage of our assets in bonds. If we need cash, we could sell bonds instead of stocks. Once the market recovers, we can rebalance back to our normal asset allocation.
In a crisis, our natural tendency is to conserve cash. This instinct becomes even stronger when we see our portfolio drop each day. It might seem smart to sell stocks and keep the money in cash because the balance won’t decrease so much. However, you don’t know when to buy back into the stock market either. I think a lot of investors missed this recent run-up. The stock market recovered back so quickly.
In conclusion, long term investors should continue to invest during a recession. It’s a good chance to buy some stocks at a bargain price. In 10 years, your portfolio will be worth a lot more if you do.
What do you think? Did you continue to invest when the stock market crashed earlier this year? It’s hard to buy when the stock market is falling, but it usually turns out really well for the investors who keep investing during a recession.
Passive income is the key to early retirement. This year, Joe is increasing his investment in real estate with CrowdStreet. He can invest in projects across the U.S. and diversify his real estate portfolio. There are many interesting projects available so sign up and check them out.
Joe also highly recommends Personal Capital for DIY investors. He logs on to Personal Capital almost daily to check his cash flow and net worth. They have many useful tools that will help DIY investors analyze their portfolio and plan for retirement.
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Originally posted at https://retireby40.org/dont-stop-investing-during-a-recession/