I have been reading a lot lately about the risks of a crash in the next few months. The reasons are numerous and I won’t bore you with further rehashing of the European debt crisis, fiscal cliff, corporate earnings slowdown, Middle East unrest or other big fear-driven headlines.
You know, “death of equities” and all that.
Instead of peeling those old onions, I’d like to address the general idea of crashes — and why they seem to intimidate investors needlessly.
Sure, it hurts to see your portfolio damaged in the near-term. But consider these points:
- For starters: The S&P 500 Index is up about 50% in the past 15 years. While you might scoff at a 3% annual return, it’s worth noting that’s better than Treasuries right now — and more importantly, it’s not in the red despite two horrible asset bubbles (the dot-com crash and financial crisis). Furthermore, the S&P 500 Total Return Index — which includes dividends — has almost doubled in that same 15-year period. That’s a 6.6% annual return across two severe crashes. If you’re a long-term investor, this is proof positive that with dividends as part of your portfolio, you can weather a rough market — even if it involves two crashes in roughly 10 years.
- Crossing Wall Street blogger Eddy Elfenbein posted in September about “The Importance of Extreme Events,” sharing some great market history. The gist: Big up days or down days come in clusters, with long lulls in between. Consider that there were “only two 4% or more days between Pearl Harbor and JFK’s assassination,” according to Ed’s research. So while crashes are horrible when they happen, they happen far less frequently than some of us think.
- Josh Brown over at The Reformed Broker has a classic from May 2012 that says, rather bluntly, that “Tops are a process, Bottoms are an event and Middles are a motherfucker. Because when you’re not at a top or at a bottom, but somewhere in the middle, you spend the bulk of your time worrying about which one of those two you’re closer to.” He goes on to say, “Most of the time, there is no inflection point at hand — these are rare occurrences. So to focus on them to such a great degree is probably a distraction and definitely a waste of time.”
- More fundamentally, a basic tenet of behavioral finance is “loss aversion.” Or simply put, the tendency to want to avoid losses more than seek gains. Google around for any number of academic articles on the subject, but the best recent example for investors might be Bloomberg Businessweek and its story about the three-year anniversary of the bull market rally — from an S&P reading of 676 in March 2009 to over 1,300 in spring of 2012 — which was decidedly lacking any enthusiasm. The money quote: “The ability to scare the hell out of people is much greater than the ability to attract them to equities.”
- On the other hand, the Bat Boy crew thinks a crash is coming. (Weekly World News)
- OK, OK … seriously, though, on the other hand, Pimco’s still super bearish on stocks. (MarketWatch)
- For what it’s worth, Ben Bernanke is bullish on 2013. (Reuters)
- If you want to get all scholarly on behavioral finance, check out this treatise on “Myopic Loss Aversion and the Equity Premium Puzzle.” (Quarterly Journal of Economics)
Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at firstname.lastname@example.org or follow him on Twitter via @JeffReevesIP.