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When you consider the potential for a future recession, how does it make you feel? Does the expected dip in your 401k keep you up at night, or are you prepared to continue investing to boost your retirement savings for the long run?
Going into March 2020, I was thankful for the advice to leave my investments alone and not sell at a loss as so many did back in 2009. Since I have only been investing for about 10 years, I knew it was important to keep my portfolio steady through the economic uncertainty.
However, I had yet to appreciate the earning potential of investing during a downturn. Buying into the market at a lower price can actually provide an opportunity to grow savings for retirement even faster.
Whether you’re only just getting started, or if you’ve got a strong portfolio coming out of 2020, it can seem counterintuitive to invest while the market is going down. In this post, we will cover the following:
- Scenario 1 – $100 is invested every week while markets reduce significantly for a period of time.
- Scenario 2 – $100 is invested every week while markets steadily increase.
- Risk assessment: Individual Stocks versus Index Funds
- Link to a simulator showing how your portfolio would drop and rebound during historical events
In the first scenario, let’s say we invested $100 per week into an index fund targeting the performance of the S&P 500 from March 1st until the end of June in 2020. In the second scenario, we invested the same amount to the same index fund from July 1st until the end of October.
The second scenario results in higher growth potential by the end of the 3 month period, however the first scenario buys into the market when prices are lower and gradually increases over the next couple months. Continuing to invest regularly during this downturn provides significant growth potential as the prices rebound.
In the chart below, the closing price for the S&P 500 is listed on the days that we simulate investing. Both scenarios will start with $100, and invest every Monday for the next 3 weeks.
Since the market dipped in March, the $100 per month actually has more buying power, as many as 0.044 shares. As the price per share increases back to where it was on March 1st, these shares bought at a lower price have now increased in value from what was initially paid.
As a result of the three month investment period, $1,800 purchased 0.63504 shares with an ending value of $1,968 resulting in $168.81 of gains excluding any dividends during this time.
Consider the second scenario where we invest $100 a week from June until the end of October. If you revisit the first chart, you’ll see that the value of the S&P 500 steadily increased over those 3 months with a few minor fluctuations.
However, due to the steady increases, the $100 doesn’t purchase as many stocks as the previous scenario because the price stayed relatively consistent. The overall stock price is higher to start with, but when we look at the delta from invested to the end value, $1,800 purchases 0.54035 stocks that end up valuing $1,766 after 3 months. This results in a net loss of $33.08
The purchasing power of the lower priced stocks in scenario 1 are much higher long term. If you are checking your balance on a regular basis, it may be frustrating to see your account drop in value, however remember you are picking up few more shares than you otherwise would have been able to.
When you schedule a regular occurring investment, there will be times when you purchase at a higher value. Therefore, it may take a little bit longer to see gains from these initial investments. While concerning if you are first starting to invest, generally the longer you stay invested, the more opportunity to you have to grow your investments. These slight fluctuations week to week are negligible long term and consistent investing is preferred over trying to time the market.
Risk Assessment: Individual Stocks vs Index Funds
Keep in mind that this scenario is using the S&P 500 and is not representative of any one individual stock. The S&P 500 is a combination of multiple stocks, and if one isn’t performing well, it will be replaced with another that is.
Historical data suggests that the long term growth of the S&P 500 rebounds and you will make your money back if you hold your investment strategy steady.
Individual stocks may not benefit from the same strategy however. We always take on risk when investing, but you take on increased risk when investing in specific companies. While the stock for a company decreases in value, you may be investing in a loser and never make your money back.
For this reason, a portion of my portfolio is invested in index funds similar to ones that mimic the performance of the S&P 500. By doing this, I carry on the risk of multiple well established companies and if one doesn’t perform well, ideally it will soon be replaced with one that does.
While the S&P 500 will drop in value during a recession, historically the value has always returned and continues to grow even as companies transition in and out based on their performance. Note that historical performance is not a guarantee of future performance, and investing comes with risk.
Preparing for a Downturn
Now that I’ve started building up a portfolio to prepare for retirement, I can’t help but cringe thinking about those hard saved dollars disappearing if we experience a market downturn.
Check out this article from nerdwallet that includes a simulator for how your portfolio would have performed during a historical downturn and how much it would be worth today assuming you didn’t sell.
We may not know when the next significant downturn will be, but I appreciate mentally preparing myself for the road ahead and reminding myself that while my investments may be dropping in value, I want to challenge myself to save even more to benefit my long term investment goals.
Questions to Consider:
- What is your tolerance for risk?
- Is your portfolio allocated appropriately for your risk tolerance?
- Have you ever paused your investing contributions as the markets trend downward?
- Have you ever invested more as your portfolio has negative performance?
- Have you ever been hesitant to start investing because you’re waiting for the market to perform better?
- Are you at risk of needing to sell investments when the value is lower?
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