How Market Downturns Look and Feel

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What do market downturns look like? Understanding what they look like or what they have looked like historically is helpful. We can’t predict the future, but we do know what happened in the past in order to navigate better if and when history is repeated.

In this episode of the Finance for Physicians Podcast, Daniel Wrenne talks about how market downturns look and feel based on market history and market factors.

Topics Discussed:

  • Long View: Have a financial plan that ties your goals to your actions
  • Timing: What if it’s not the right time? Maybe it’s the worst possible time to invest
  • Franklin Templeton: People recover fast, the scariest time may be when to invest
  • Financial Information: Where to get it and who to trust
  • FOMO: Fear of missing out on what everybody else is doing with investments
  • I Bonds: When inflation is high, investments are terrible, they look appealing
  • Reminder: What is the purpose of the money and what’s the goal?
  • Alternatives: You’re potentially moving away from the best route for your goals


Playing the Probabilities – Wealth of Common Sense Blog

What If You Only Invested at Market Peaks? Bob – The Terrible Market Timer

Learning from the Lessons of Time – Franklin Templeton Brochure

What To Do When Your Investments Start Tanking

The Power Of Diversification

Investing During Wild Markets with David Blanchett

Free DIY Financial Planning Guide for Physicians

Dow Jones Industrial Average

Contact Finance for Physicians

Finance for Physicians

Full Episode Transcript:

What’s up, guys? Continuing on with the theme of last time, we’re going to be talking about downturns in the market. We talked about (last time) how to navigate a scary investment market, and I gave you some tips on actions you can take.

I think the big takeaway from that conversation was making sure you have a solid financial plan that includes an investment plan. If you don’t have one of those, that’s important to create first. It’s always good to consult your financial plan, especially when things get dicey and emotional like they are in scary markets. Try to avoid making changes or taking actions based on things that are out of your control and emotions that come into play. Definitely check that out if you haven’t listened to that as a precursor to this.

Today, we’re going to be digging in a little bit more into what those market downturns have looked like historically. I think this is part of the education component. Understanding what this looks like or what this has looked like in the past is really helpful. It has been for me. Of course, we can’t predict the future, but we do know what history has looked like, so we’ll talk about what that has looked like historically so that you can have a little bit more of that education and be better armed to navigate it as this type of thing happens again in the future.

Okay, we’re going to be referring to a few sources today to give you guys some hard data. I’ll link to the stuff that we mentioned today in the show notes. They have pulled together some of these numbers and concepts, so definitely check those out. We’ll link to any of those sources, as I mentioned.

The first concept I wanted to talk about was making sure to have a long view. We talked about it last time in the last episode about having a financial plan and making sure you tie your goals to your actions. With investing, if you have a long-term goal, that’s where investment can work really well because investing is a long-term thing. You should not be investing for short-term goals. Using that approach, it’s not about the short term. If you’re looking at the short term, that’s not really the right view for something that’s not going to be needed until the long term.

Also, looking at the investment data, the short term has been relatively unpredictable. The first source that I wanted to look at was the probabilities of how the market is done based on different time frames. The source that I have here is A Wealth of Common Sense blog. This is a blog from Ben Carlson and he’s very much into investing and gets into some of the weeds of investing. If you’re interested in that, this is a good blog to check out. He’s a smart dude and writes a lot about this type of stuff.

Anyway, he wrote a blog a while back where he shared the probability of positive versus negative returns based on different slices of time. He looked at the entire period from 1926–2015 of the S&P 500, which is the 500 largest stocks in the US. He looked at it for varying slices of time, was it positive or negative?

First, he looked at daily slices of time. For every day, over that entire 1926–2015 time period, how many days were positive versus how many were negative. Positive was 54% and negative was 46%. Basically, a day in owning the S&P 500, it’s almost a coin flip, slightly better than a coin flip. It’s better than going to the casino, better than a lottery ticket, but not great, especially for your life savings. That’s part of the problem. When you’re looking at it daily, close to half the time, it’s down. It’s just unpredictable.

When you go quarterly, it’s 68% positive and 32% negative. One year slices of time over that entire 1926–2015 time frame, it was 74% positive and 26 negative. And the five-year period was 86% positive and 14% negative.

Basically, the further out you go, it increases that positive percentage to the point where at 20 years, it’s 100% positive. I think probably he has ten years as well at 94% positive, but it’s got to be somewhere in between 10 and 20 years, which he did not calculate. Somewhere in between there, I would guess it’s hitting 100% before 20 years.

The takeaway is the longer you go out, the higher your odds of getting a 100% outcome positive returns, no matter which slice of time you look at up. The key is to take that long view and tie it to long goals. Really, you shouldn’t worry about the short term because it is more like a coin flip. What you need to focus on is the long term.

The next concept I wanted to hit on was timing. I think a common concern is what if it’s not the right time? Maybe you’re investing at the worst possible time and you just don’t realize it or maybe you’re worried that it’s the worst possible time. The video that I will link talks about—it’s a hypothetical example based on the actual returns of the market—they call him Bob, the Story of Bob, The Worst Market Timer.

Anyway, they share Bob’s journey as an investor who basically times his investments at the worst possible time. He buys at the peak of the market right before it tanks and it shows you how things turn out for him over a long period of time. Where Bob messes up, as he worries about it, and ends up investing when everything feels great, and typically that sometimes happens at the peak.

Basically, he has bad luck and times it at the worst possible time possible every single time. He does that bad, but the good thing is he keeps his money in the market and does not change it.

You’ll see from the video that things still work out pretty well for him because he holds his money in there long term. That’s the important thing. As I mentioned in the first point, you have to take a long view. It has to be a buy-and-hold sort of approach.

Ideally, you’re not trying to time it. That’s the mistake he made. A much better approach is to remove that decision from the equation. You should not be trying to predict when the best time is to put it in the short-term period of time.

Going back to the first point, we don’t really know what it’s going to do in a short period of time. You just have to invest based on your own circumstances, and it’s generally best to put it in systematically over time. Maybe you’re investing monthly at the same time every month.

Ideally, you remove the emotion and the decision-making from the equation and systematize it and it just happens. You don’t have to worry about this whole timing thing because most people that start to try and worry about the timing thing tend to get it wrong. They tend to gravitate towards this example of Bob timing it terribly. So that’s Bob.

The next example I wanted to look at was the reverse scenario. What if you’re investing at the worst possible time when the market feels terrible? The Bob scenario was like he was investing only when it felt great and when the news was great, but what turned out to be the worst possible time.

This example is looking at what if you invested when we looked back and we knew it was terrible? At the bottom of the market. What if you’re investing at the worst possible time in reality? Maybe you don’t know it at the time, but it’s the bottom of the big market downturn.

You can look at all the examples. This piece that I’ll share is from Franklin Templeton. There are four examples in it. I’ll just talk about the most recent one, which is 2007–2009. They all have the same sort of takeaway, but that was the big housing crash crisis in 2008.

In that particular downturn, from the peak down to the trough, the S&P 500 index went down just over 50%. It was 50.95%. Check out the PDF link for all the details on that and the disclaimers are in there, too, so definitely read those.

That was the 2008 crash from peak to trough. Then they look at what if you invested at that bottom point? The thing is, looking back, you’re like oh yeah, duh, that’s a great time to invest. If you were looking at it objectively and investing in that period of time, it felt like a terrible economy. Everything was negative. It just didn’t feel like a good time.

The world was telling you not to invest, but if you had invested at the bottom of the market, one year after your cumulative return was 53.60%, then five years after it was 137.49%, and then ten years after it was 367.39%.

The takeaway is these downturns, it goes down fast and feels super scary. A lot of times people don’t realize how fast it recovers and how quickly we can get back to where we started. Oftentimes, the scariest point in time is actually when it’s a fantastic point in time to invest.

Same sort of thing as I mentioned in the first point. I think the takeaway is you don’t want to try to time it now, but if you do happen to have extra money, if you’re going to be timing it lower when it’s gone down, it’s actually a better time to invest. At the end of the day, you want to have your dollars working for you and make sure you’re investing that based on your financial plan and not based on where you’re predicting the market might go.

We don’t really know what the short term is going to do, and these sorts of things happen. It’s very difficult to predict at the moment. I think the temptation, though in that bad market is to maybe stop investing. You definitely don’t want to do that. Or I guess a different temptation. Sometimes people that have even more fear might even be tempted to bail out.

I think that’s probably the most important thing to try to avoid. Basically, if you had bailed out at that bottom in 2008, you’re missing out on all that upside in recovery. You’re basically cashing all your chips in at the worst possible time. If anything, do not go down that path, and really you should be continuing to invest based on your plan.

There is a temptation to move away from the pain. It does feel painful when things are down, but you want to avoid that temptation and look at something like this piece I’ll share with you and remind yourself how quickly things return to normal. Typically, when it feels like it’s the worst period of time, oftentimes it’s the best period of time to invest.

The next concept, which is in the same PDF that I was just referring to, is oftentimes, when it’s really bad or when you just feel unsure about things, I’ll sit out for a few days. I’m just going to give it a few months. I’m going to stop investing for a few months or go to cash for a few months and let the dust settle, or something along those lines.

This visual, this chart looks at the S&P 500 again, and it looks at 20-year periods ending December of 2021. If you’re fully invested for that period of time, the return you would have had for that period of time is 9.46%. If you had excluded the ten best days, or 20, or 30, or 40, or 50, or 100 best days, it’s basically looking at if you had excluded X number of days from 10–100, what would that have done to your returns?

Just missing out on the 10 days out of a 20-year period of time, if you’ve missed out on 10 of the best days, it knocks your return down by down to 5.27%. If you miss the 40 best days, it knocks your return down to -1.57%. If you missed the hundred best days, it knocks your return down to -10.06%.

Basically, you don’t want to miss out on those good days. The problem is the days are really difficult, or really impossible (actually) to predict. You have to be invested fully for that entire period of time to get the maximum return. I think that’s a very important takeaway.

Sitting out for a few days doesn’t work out well in the end. It’s much harder to know when to get back in and oftentimes you start missing out on these good days. Now all of a sudden, it’s too high to get in, at least that’s what you tell yourself. You don’t want to start going down that path.

I think the other big temptation with any big story like this is to start tracking with the news. A lot of times, it’s where people go for their information. Maybe it’s not the news on TV, but maybe you’re on social media, or wherever you’re getting your information. Let’s just call this financial information, to go to your sources of financial information and get the word from them.

The problem with the general financial information out there is it’s a terrible predictor of the future. This visual is kind of cool. It’s the same piece from Franklin Templeton. It’s a really good piece because it hits on all these concepts, but this goes through a really long period of time.

This is going all the way back to 1972 and it goes through some of the big news stories and how the market behaved over those periods of time. It’s looking at the Dow Jones Industrial Index, which is a pretty good measure of the market. It’s not my favorite, but it’s still an okay measure of the market.

Anyway, what tends to happen is the worse the news gets, the better time it is to invest. In 2020—that’s the recent one everybody remembers—unemployment and the pandemic. Unemployment is at the highest rate since the Great Depression. I think that was the big financial news story. There was a lot of talk of recession and all that stuff. It’s like who in their right mind would want to invest?

Those news stories get more amplified the further it goes down. Actually, if you go back in history and you look back, that’s actually the better time to invest versus just a year before, there wasn’t really much of any news. There weren’t big-time headlines about the markets like there were in March of 2020. It’s almost like the bigger the headlines get, the better it is to invest.

It’s the reverse of what you would think it would be. When the news says don’t invest, at minimum, continue investing. That’s the important thing because you don’t want to get into this whole timing cycle, as I’ve already mentioned a million times and I’ll continue to mention because it’s important. You don’t want to get into this trying to time the market mentality. It’s super easy to get into, but we don’t know what the future is going to hold, especially for a short period of time, so you just have to systematize it.

The news is especially terrible, but it is a big temptation that can pull you away from systematizing this and trying to time the market. The temptation is going to be like things start to get negative, and the news starts to tell you it’s negative. Right now it’s getting negative. The news is saying that negative inflation is high. Everybody’s going through a recession, the market, the war, all this stuff. You’re going to be feeling a little tempted to say, maybe I should stop investing my monthly investment because it’s going down.

Definitely, you don’t want to stop that systematized approach based on your plan. That would be a bad move, especially based on the news. They’re terrible at this stuff. You can see from history, that it’s very much shown through history over and over and over again that they’re terrible predictors of the market and it’s best to not make decisions based on what you’re seeing in the news.

You can also see this in, my favorite example is cryptocurrency, because it seems like cryptocurrency, everybody starts talking about how good it is. As the price goes up, people talk about how good it is, and as the price goes down, they question it. But it’s the reverse of how it should be.

Not that I’m endorsing cryptocurrency, but people talking in the news are a good representation of human nature, but a bad representation of what actually happens. The important takeaway, as I said, is not trying to time this stuff because it’s incredibly impossible. It’s just not possible.

I think another common thought that creeps into the equation when markets get dicey, that I’ll talk through before we wrap up today, would be this alternative that’s creeping into the equation.

Oftentimes—we hear this from clients and I felt this temptation with my own finances—clients will ask us on occasion what about the XYZ alternative? Like cryptocurrency, I bonds, real estate, or GameStop stock is an example that was popular a few years ago, or maybe investing in gold.

Oftentimes those will come up. I think the question is to ask where is that coming from? Normally it’s presented as an alternative, or diversification, or some sort of reasonable approach as a good investment. It’s a little different than what we’ve talked about so far. It’s not necessarily getting out of investments. It’s not really necessarily timing investments. It’s more of changing what you’re invested in.

Typically, if you peel back the layers, it’s based on some underlying fear of whatever your primary investment is. Sometimes it’s FOMO (fear missing out), everybody else is doing it kind of a thing. A lot of times it’s just fears of investments going down or not being as productive as the alternative.

Lately, the most common thing that’s been coming up is I bonds. Investments have been going down as of this recording, and inflation has been going up. An I bond is really the only thing that mimics or is pinned at inflation. It’s a government bond that pays exactly what the inflation rate is. I bonds are the best possible investment that keeps up exactly with inflation. When inflation is high and investments are terrible, it starts to look more appealing.

As I said, typically what happens is people are having greater fear with their investments as they go down because they’re worried maybe they’re not going to do as well, especially the further down they go. Then the further up inflation goes, they’re thinking that’s a better alternative. The temptation is to switch from investments to I bonds in just this example, you can use any example.

The problem is it’s based on short-term view and fear. If you peel back the layers, it’s this fear that the market is not going to do as well and it’s looking at this slice of time or really just not thinking about the long term. If you’re investing, it should be for long-term goals.

You have to remind yourself. That’s why it’s important to remind yourself what is the purpose of the money and what’s the goal and the purpose? It should be some sort of long-term goal. Otherwise, it should not be invested. If it is long-term, you have to keep that long view in mind that I’ve been referring to.

All this alternative stuff I’ve been talking about, at least so far, is kind of based on the short-term view and short-term fears. If I look historically at inflation and historically at investments, I think that’s the best reminder of how these things work. Long-term inflation and long-term investments are good reminders.

If you look at the short term, it’s very emotionally prone to driving you to be fearful because right now inflation is high, investments are doing bad, but long-term investments will recoup. Long-term investments have considerably outperformed inflation over all periods of time if you look at it a long-enough period of time.

Inflation or I bonds, for example, are not a great long-term investment. I think the key is to consult your financial plan. What are the goals? Focus on your situation and avoid this temptation to make changes to different things that are not in line with your goals and your purpose.

That’s the issue usually with these alternatives and really all these different concerns or fears around the market. The issue is that you’re moving away potentially from what the best route is for your goals, so you want to really keep that focus on that.

At the end of the day, short-term markets are very unpredictable, and you have to be careful not to tie that to a short-term need. You shouldn’t be using investments for short-term goals and so don’t let those short-term markets knock you off track. Remind yourself those investments are tied to long-term goals, and you got to take that long view because long-term markets are far less volatile and will really do well for you.

History is such a great reminder of that. If you look back and you spread it out over a long enough period of time, those numbers start to look really solid. Even if, like we talked about today, you’re timing it at the worst point in time possible, things will tend to work out and flatten out if we can extend that slice of time over a long enough period of time. I think that the key is really taking that long view and as I said several times, focusing on your plan and your goals, and not on these external factors and fears that inevitably crop up in our world from day-to-day, week-to-week, or month-to-month.

All right, guys. That’s it for today on market history and market factors. Next time we’ll be talking a little bit about some of these behavioral tendencies and biases we have as humans. We’ll go through some of these. I think these are super interesting. We’re all prone to them and they can really cause some problems in our world, particularly in investing and personal finance. We’ll look forward to talking about that next time.