Should You Be Afraid of a Stock Market Crash?

Bear Markets

US stocks have been on a tear over the past 6 years, with the S&P 500 index of large US stocks returning over 200% since its nadir in March 2009. Such a lengthy bull market can lead to concern about when it will inevitably end; after all, stock markets tend not to rise forever. But if such fear leads you to hoard cash rather than invest it, you’re likely making a mistake, particularly if you have a long time horizon for your portfolio.

To see why such fear is mistaken, let’s take an example where you invested $1,000 in the S&P 500 index at the start of each calendar year. Even in an extreme situation where your timing was abysmal and you began making these investments near the starts of the worst stock market downturns in history, after suffering some sizable early losses you’d still be in positive territory within a few years.

The worst of these downturns was during the Great Depression. Even if you began in 1929—the beginning of an epically nasty bear market where US stocks lost 2/3 of their value of from the start of 1929 through the end of 1932—you’d have more money than you put in within 7 years. In less prolonged slumps the recovery would take far less time: if you started in 2008, you’d be back in the black by the end of 2009.

These results suggest that for investors with a long time horizon, the downside of even a worst-case scenario isn’t that dire. Having a more diversified portfolio containing other asset classes in addition to US stocks could reduce risk even more.

By contrast, there’s plenty of peril in holding too much cash. The “what goes up must eventually come down” logic can be applied at almost any point during any bull market, so using it will almost certainly cause you to miss extended periods when markets perform well. In fact, stock markets reaching new highs are generally a sign of a protracted bull market rather than an imminent collapse. Unless you’re able to time the market with far more precision than financial professionals can, keeping your money in cash rather than investing it is likely to result in a smaller portfolio over time.

Topics: Blog Stock Market Risk