Can Stocks Go to Zero?

The recent rout in stocks has been unnerving.  The rate of decline has been swift and violent.  In less than two weeks it has fallen more than 9%. Market corrections aren’t fun but they’re normal.  Up markets follow down markets and vice versa just as spring follows winter.   Stocks can’t go to zero and snow eventually melts.

Since 2008 the stock market has climbed more than 106%.  However, this rise hasn’t been without disruption.  Over the past ten years there have been five double digit percentage declines, or about one every two years.  In 2008 it plunged 50%.  In 2011 it dropped 18%.  In 2015 it fell 16%.  In 2016 it declined 13%.  This year it has fallen 9%.  Despite these drops a buy and hold investor still managed to generate an average annual return of 7.5%.  A $100,000 investment ten years ago is now worth $206,100.

Dating back to 1928 the stock market has finished a year in negative territory 24 times, or one in every four years.  Throughout the past 90 years it has averaged an average annual return of 9.6%.

Paradoxically, when stocks fall they become safer.  Valuations become cheaper and dividend yields increase giving you an opportunity to buy at attractive prices.

An investor who purchased the Dimensional Funds Core Equity 1 mutual fund (DFEOX) on October 1, 2007 enjoyed a gain of 135%.  A $100,000 investment grew to $235,000.  If she waited until March of 2009, after the market had fallen 50%, her initial investment would be worth $484,000, a gain of 384%.[1]

What can you do to protect your assets?  Here are a few suggestions.

  1. Follow your financial plan. Your plan should give you peace during a market decline because your investments will be synchronized to your goals. It’s your financial GPS.
  2. Diversify your assets. Diversification is the only free lunch on Wall Street. A diversified portfolio allows you to own securities from around the world.   In addition, you can reduce your risk by adding cash, bonds and alternative investments to your portfolio.
  3. Invest in cash. If your time horizon is three years or less, move some money to a cash account, CD or T-Bill.  Do you have to pay tuition?  Buy a home? Payoff your mortgage? Take a trip? Buy a car?  If so, invest this money in a secure instrument that won’t lose value.
  4. Buy the dips. If your time horizon is greater than five years, buy the dips.  The market in the short-term is unpredictable but over time it has risen.
  5. Buy funds. A portfolio of mutual funds will give you more diversification than one that only invests in common stocks.  A mutual fund will allow you to own thousands of securities.
  6. Dollar cost average. Set up an automatic investment plan that allows you to buy stocks monthly.  Automating this process will remove your emotions from your investment decisions.
  7. Focus on the percentage not the point. A 500 point drop in 1987 was 22%, today it’s 2%.
  8. Think long-term. There are about 72,000 individuals who are older than 100 living in the United States.  This number could rise to 1 million by 2050.[2]   A person who retires at 65 could spend 35 years or more in retirement!
  9. Turn off your media outlets. Pundits, reporters, and commentators do a great job to stir the pot during a market retreat.  They dramatize the information for millions, but they know nothing about your specific situation.

The stock market has been fluctuating for centuries and it will probably continue to do so long after we’re gone.  Focus on your goals, diversify your assets, think long-term and good things should happen.

“Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria” – Sir John Templeton

Bill Parrott is the President and CEO of Parrott Wealth Management an independent, fee-only, fiduciary financial planning and investment management firm in Austin, TX.  For more information please visit www.parrottwealth.com.

2/1/2018

Note:  Past performance is not a guarantee of future returns.  Your returns may differ than those posted in this blog and investments aren’t guaranteed.

 

 

 

 

 

 

[1] Morningstar Hypothetical Tool, returns through January 2018.

[2] http://www.thecentenarian.co.uk/how-many-people-live-to-hundred-across-the-globe.html, Steven Goodman, January 17, 2018.

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