Lessons We Can Learn From The Stock Market Crash and Recovery
The Dow Jones Industrial Average closed at 14,700.80 today which is just off its all-time high. It has surpassed where it was before the 2007 financial crisis.
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It took about 6 years for the market to get back to even and the lesson here is that investors who are in it for the long term (10 years or more) usually do okay.
When the market started crashing in late 2007 all the way through 2009, a lot of investors left the equities market and went into bonds or GICs. While it is prudent to protect your capital, the problem is, these same investors were slow to get back to the market.
At its peak in 2007, the Dow Jones was at 14,093.08 and went down as low as 6626.94. It’s impossible to time the market and nobody knew 6547.05 would be the bottom of the market. But as the market started coming back from the low, investors were still sitting in bonds and GICs.
When the Dow Jones hit 8,000, people were still in the sidelines waiting and being cautious. At 10,000, people started slowly reinvesting in the market and most are quite happy as they probably made money.
However, the increase from 6547.05 to 10,000 represents a 52% gain that a lot of people missed because of fear. Obviously, we cannot dwell on the past, but there is a lesson to be learned here.
Some people were able to take advantage of that gain from 6547.05 to 10,000. And those are the people who do regular monthly or weekly contributions to their investments.
This investment strategy is called Dollar Cost Averaging, wherein you invest the same amount of money at regular intervals, say weekly or monthly. You take advantage of doing a regular savings program while avoiding market timing.
Think of it this way. If you invested $100,000 at the peak of the market in 2007, at the bottom of the market in 2009 you would have lost more than 50% of your principal. Assuming you never withdrew your investment and kept it invested, you would have been back to even and a little more today.
Let me give you an example.
Compare two people, Bob and John who are investing $100,000 into the Dow Jones Industrial Average (DJIA). Let’s say Bob wants to invest the whole $100,000 on January 2008 and John wants to invest $100,000 in regular intervals at $5,000 per month starting January 2008 until he uses up the whole $100,000.
Bob buys the DJIA on January 2, 2008 at 13,043.96. His $100,000 will buy him 7.6663 shares.
At the bottom of the market on March 9, 2009, the DJIA is at 6547.05. This means that Bob has lost 65% of his principal.
Assuming he has a strong stomach and held on to his investment up to today. At 14,700.80, his $100,000 investment would now be worth $112,700.74, representing a 12.70% total return.
John on the other hand decided to spread out his investment over time. He is going to start investing $5,000 a month for 20 months starting January 2008 up to August 2009 which includes times near the peak of the Dow Jones and pass the bottom of the market on March 2009 to when it started going back up.
At $5,000 a month for 20 months, that equals a $100,000 investment. He bought the following
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John bought the DJIA while it is going down and a few months while it is going up from April to August 2009. The total number of shares John was able to buy was 10.17887. More than what Bob was able to buy and the average price John paid was $10,230.09. Less than the price Bob paid for his investment.
As of today, the value of John’s investment is 10.17887 x 14700.80 = $149,637.53. This means that John had a 49.64% total return on his investment compared to a 12.7% return for Bob.
John didn’t do anything different other than spreading out his investment over time. This gave him the benefit of buying more shares when the market is low. It also eliminated the risk of timing the market hoping that he invested at the bottom of the market.
A simple strategy like this could mean a lot for your investment.
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