Written By, Scott Adair, CFP®
Ten years ago in September 2008, the global economy stood on a precipice and quickly slid into the worst recession since the 1930s. In fact this period has since been named The Great Recession. The U.S. housing market began heating up in the early-2000s, with home sales and prices soaring to unprecedented levels. Banks, after being deregulated by congress in the late-1990s, began selling complex and risky investment derivatives called mortgage-backed securities (MBS) and collateralized debt obligations (CDOs), to other financial institutions and pension funds. The underlying collateral for these investments was consumer home loans.
The popularity of MBS and CDOs, along with low interest rates and a universal belief in the virtues of home ownership, increased the demand for more home loans. Mortgage lenders were highly incentivized to sell subprime mortgages to buyers with poor credit. Many consumers believed home prices would only continue to rise, and began using their homes like ATM machines by taking out equity loans. Real estate speculators bought multiple houses and “flipped” them to other buyers at a higher price. All manias come to an end, and eventually the housing bubble burst in 2007. Home prices in the U.S. fell dramatically and home owners could no longer make the payments on their subprime mortgages, leaving them “underwater” (home values worth less than what is owed). The values of MBS and CDOs also plummeted, taking down financial giants Lehman Brothers, Bear Stearns and AIG who owned trillions of these financial instruments. These events ushered in the worst stock market crash since 1929, and it would take years for it to recover.
Fortunately stock market downturns of this magnitude are rare, but history tells us that corrections are a normal part of our economy. In order to reap the rewards of stock market gains, investors must accept the risk that their portfolio can go down from time to time. It is natural for investors to want to avoid the pain of a downturn and sell their stocks, but this is the exact opposite of what is required to succeed in the market. In order to achieve their retirement goals, investors should be prepared to stay invested in the market through good times and bad. In fact, when the market goes down, we advise our clients to view this as a buying opportunity and invest in equities while they are low. Historically, the U.S. stock market has recovered and eventually gone on to new highs. Investors who buy and hold a portfolio of highly diversified, low-cost mutual funds give themselves the greatest odds for success.
Some investors think they can time the market and avoid downturns, then get back in at the market bottom. The problem with this approach is you have to be right twice (when to exit and when to re-enter) and this would require a crystal ball, which nobody has. History shows us that when the market recovers, it often happens very quickly and in a concentrated number of trading days. For example, between 1980 and 2017, the S&P 500 Index had an annualized return of 11.7%. If you remove the best 15 trading days in that 37 year period, the return drops to 8.9%! This illustrates the importance of taking the long view and not trying to beat or time the market. So remember, the next time we experience a stock market downturn, take a deep breath, remind yourself that we have been here before, and stick to your plan.