How should I invest following a downturn?

During a downturn, it’s normal to want to flee to cash, but it’s not likely to be in your best financial interest to do so. Let’s explore some options for what to do when faced with a declining market.

 


 

Investing After a Decline

After a significant decline in the stock market, investors have a range of options, including staying in the market, investing more immediately or moving to cash and re-entering the market later.

The chart below shows the results of seven different strategies for a hypothetical $100,000 stock portfolio during and after the market downturn of the 1970s.

THE EFFECT OF THE 1970S DECLINE ON A STOCK PORTAFOLIO

As the chart shows:

If you had invested $100,000 in the S&P 500 Index on January 1, 1973, at the market peak, by September 30, 1974 your account would have dwindled to $57,274.

By September 30, 1989 — 15 years later — the seven different strategies we’ve shown would have produced very different ending portfolio values.

Investing an additional $100,000 at the market bottom would have been the best long-term investment strategy.

A dollar-cost averaging strategy was the second best performer. Without the benefit of hindsight, however, it’s almost impossible to know where the market bottom is. That’s why a dollar-cost averaging strategy could be a useful alternative.


Dollar-Cost Averaging in Declines

If dollar-cost averaging can be the “how” of investing after a downturn, what about the “when?”

The chart below compares the hypothetical results of five different starting points for a dollar-cost averaging investment strategy during and after a market decline.

THE EFFECT OF THE 1970S DECLINE ON A STOCK PORTAFOLIO

As the chart shows:

A $100,000 investment in the S&P 500 on January 1, 1973 would have dwindled to $57,274 by September 30, 1974.

If you had invested an additional $100,000 in the market using a dollar-cost averaging strategy, you would have done best if you had begun your additional investing before the market reached bottom. This suggests that if you wait for a clear sign that the market is recovering, you may be too late to capture all of the market’s upside potential.

Investing involves risk, including possible loss of principal.

Systematic investing does not assure a profit or protect against a loss in declining markets. Dollar cost averaging involves continuous investing so investors should consider their ability to make periodic payments in all market environments.

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