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How Often Does the Stock Market Crash? | Portfolio Rescue


Chapters

0:0 Intro
1:28 Diversification.
6:59 Market crashes.
12:11 Saving for college.
21:0 What is the best tax-advantaged account?

Transcript

(beeping) (upbeat music) - Welcome back, Portfolio Rescue. Each week we get tons of questions from YouTube viewers and podcast listeners and blog readers. And this is a show we created to answer those questions. Remember, if you have one, askthecompoundshow@gmail.com. Duncan, we're in a nice little correction here. So, last year, peak to trough, worst drawdown on the S&P 500, 5.2%.

As of the close on Wednesday, yesterday, the S&P was down 5.5%. That doesn't sound too bad. We look at other areas of the market, NASDAQ 100 was down 9.2% and small cap stocks were off almost 16%. So there is a market getting dinged right now. I don't think our inbox reflects this quite yet.

We did get a couple questions on corrections. We're gonna talk about that a little this week. How are you feeling? - I mean, things have only gotten worse for my robin hood since last week. But the good news is I feel like I'm a little more numb to it now.

- I mean, that was the one thing that all these other stocks are getting killed and the stock market's still at all time highs. That had to be the big worry of, okay, but what happens when the market rolls over? It's not like these stocks are gonna start going up when the market goes.

So, who knows? We're gonna talk a little bit today about how long corrections take and we'll get to that in the second question. But why don't we do the first one here and try to think more positively? - Yeah. Okay, so first up today we have, so I know it's a little bit of Michigan bias in the questions this week, but that's cool, that's cool.

So, first, is it just me or does everyone hope to run into Ben whenever they're in Grand Rapids? Second, we all know Buffett's feelings on the S&P. Kramer says to put your first 10K into the index every year and so on. Does S&P 500 provide enough diversification over a 20 plus year time horizon?

If I want to set it and forget it from age 30 to 50, do I really need anything more than to automate into VOO? And VOO is the world market index? - No, VOO is the Vanguard S&P 500 ETF. So, there's a million S&P 500 ETFs. He's basically saying one of those Vanguard S&P 500 ETFs.

And by the way, thank you to our flyover state questions here, I appreciate it. Someone coming from West Michigan, not a coastal elitist. I know you're more prone to these New York questions, Duncan, but it's nice to know the West Michigan faithful's here. John, let's throw up the first chart.

So, this person's asking, 20 years, how can I reasonably feel good about the S&P? This is the rolling 20 year returns, going back to the 1920s for the S&P 500. You can see there's a wide range of results. The good news here, there has never been a single 20 year rolling period in the S&P 500 to start at any month you want that has been negative.

Not one, obviously this doesn't include things like taxes and transaction costs and all that stuff. Or inflation, but still, pretty impressive. There's never been a 20 year period with a loss over the last 100 years or so. But, that's a wide enough range between the best and the worst that you could drive a truck through it.

So, the best 20 year return, it was 18% per year, ending in 2000, so you had this wonderful run in the 80s and 90s, 2700% return in the S&P. The worst return, you had a total return with dividends of 45%, that's like 2% per year for 20 years. Of course, that started in 1929.

So, you invest in September 1929, over the next 20 years, not only are you experiencing the bone crushing crash of the Great Depression, then another 50% crash in 1937, but you're getting 45% in total. And basically, your whole return there and then some comes from dividends. The price was still not back at those levels.

So, I know a lot of people think that these days, the S&P must be enough because listen, it's a globalized world, the S&P now gets something like 40% of its cash flows or its revenue from overseas. I guess the problem with this in terms of diversification, there's a few things.

So, John, let's put the next chart up of the decade return. So, this is returns by decade in the U.S. stock market. And you can see the 1930s, we had sort of a lost decade. The 2000s, you had this lost decade. And then, of course, you have your good times, like the 1950s, the 1980s, the 1990s.

2010s were great as well. But it's not like those are consistent from decade to decade. So, you can have these bad times. So, let's do one more chart here, the lost decade. So, this is the total returns from 2000 to 2009. S&P 500 at a total return basis was down 9%.

But then you have all these other components of the market, European stocks, mid-caps, high yield, the aggregate bonds, small caps, emerging markets, REITs, all did so much better. So, you had this lost decade in the S&P 500, but everything else seemed to do just fine in that time. So, you had all these other sectors picking up the slack.

And now, of course, we're seeing the reverse, where the S&P is doing so much better than these other components, and these other ones are lagging. So, I guess from a diversification perspective, one of the ways to think about this is, could you hold the S&P 500 for 20 years and do fine?

Probably. The problem is, could you live through a really terrible decade to see what happens? Like, can you handle that? So, from a diversification basis, you're basically putting all your eggs in one basket of large cap stocks. So, in the top five for the S&P 500, it's 23% of the total, okay?

For the top 10, it's 31% of the total. The top 25 is 43% of the total, and the top 50 is 56% of the total. So, you're putting a lot of eggs in these one segment of the market, these large cap US corporations, which, to be fair, have done amazing over the past 10, 12, 13 years.

But I think, not diversifying enough beyond that, for me, personally, I would have a hard time doing that. - Yeah, do you think, looking, I'm looking at those returns over the years, do you think people's expectations now, after the last couple years, are set so high, especially young investors, that, like, having a 7% return is gonna seem like a bad year?

- Yeah, and I do think that there's this thing where you see international stocks, and you go, why would I ever want to own those? US stocks give me everything. I get all the tech stocks. I get everything that's going well. So, I get that feeling. I just think you're setting yourself up for a potential concentration risk.

Even though the S&P is a diversified holding of US stocks, it's specifically US large cap stocks, and then, going one step further, it's mostly US large cap growth stocks, because it's so heavily weighted towards those biggest names. So, that's the way I think about it, in terms of, could you add a little more diversification in there?

I think it probably makes sense. - Cool. So, up next, oh, that question, by the way, was from Ken. So, Ken might find you in Grand Rapids at some point. - All right. - And, yeah, y'all will have a good time. - If I'm with three screaming kids, you know that just, it's not my day.

- Yeah, I was wondering if there's a place you wanted to tell everyone that you hang out all the time, that they could find you or something. - Home, I guess. - Okay, so, up next, we have the following. I just started investing in 2020, and this is my first real correction.

I know downturns are inevitable, but how much longer do you think this could last? Should I change the way I invest now that my portfolio is getting killed? - All right, so we talked a little bit about the correction at the start here. Especially as a young investor, if you've ever been through this, you just have to understand that this is a feature, not a bug, of markets.

So, John, let's do the quick chart here. So, I look back from 1928 to 1921, and this is intro year for a calendar. How often do we experience a correction? So, basically, every year you see a 5% correction. It's very rare that doesn't happen. 10% correction happens roughly 2/3 of all years.

You're likely to see a bear market one out of every four years, and then a 30% correction, maybe one out of every 10 years. 40% is a little harder to come by. That's more like one out of every 20 years. And, of course, these are averages, so it doesn't mean they happen on a set schedule like this.

This is just the average over the long term. Now, as a young person, I'm not quite a young whippersnapper like I used to be. I turned 40 this past year. According to Social Security, like the actuarial table, I should live to be 79 years old based on where I am right now.

Let's say, take a higher end of that. Let's say, you know, Ben's in pretty good shape, eats well, works out a little bit. Maybe I'll live 'til I'm 90 or 100. So, I potentially have four or five decades left ahead of me. I mean, realistically, I'm planning on, I don't know, eight to 10 more bear markets, five or six market crashes, and what I constitute like a market crash, like maybe 30, 35% or worse.

I don't know, seven or eight recessions in my career. So, if you're 20, you know, add a few on to that. This is just something that's going to happen. So, I did look back. So, the first data I showed there was from 1928. If you include the 1930s, there's way more corrections 'cause the market was just getting drilled all the time after the Great Depression, but if we go back modern times, let's say 1950, post-World War II era, it's like 72 years of data.

There's basically been a correction, and what I define a correction as is 10% every two years. A bear market once every seven years, and a crash of 30% or worse once every 12 years. So, obviously, a correction is way more likely to happen than a crash. Crashes seem like they happen all the time.

It's really quite rare. Now, if we go to something a little more volatile, like the NASDAQ, again, a correction probably once every two years, and this is since 1970, a bear market once every four years or so, and then a crash once every seven years, and in the NASDAQ, crashes are way worse.

So, the NASDAQ data goes back to 1970. The first big crash then was 1973, '74 bear market. The S&P fell like 48%. The NASDAQ was down 60. Then we have the dot-com blow-up. Tech stocks did way better in the run-up, but when the S&P fell 50%, the NASDAQ fell 80%.

So, a lot of these times, you're gonna get maybe better returns, but it's gonna be more volatile, more corrections. Same with the Russell 2000. The Russell 2000, since 1979, it goes back to, it's seen a correction once every two years, a bear market every four years, and a crash once every six years, and since 2008, the bottom, the S&P has had one bear market of 20% or worse.

That was last year in a corona crash. The Russell 2000 has seen that four times. So, again, depending on how diversified you are and what you own, the type of stocks you own, you should expect to see these corrections and crashes. It's just gonna happen. Now, as to should you change your portfolio or your investment plan based on a market downturn, I mean, I could count on one hand the number of people I know that can do that, that can say, I can change the way I invest from a bull market to a bear market and be fine, do it consistently and do it well.

I just think it's really hard. It's really hard to do. So, I think the idea here, especially for a young person who's decades ahead of them, you build your portfolio with downturns in mind. So, the understanding that downturns can and will happen in your portfolio or your saving strategy just has to be durable enough to survive those periods.

So, either emotionally or asset allocation-wise, where you hold more cash or bonds to be able to see through that. That's the idea here, but I think trying to change your strategy just because something's going down, you just have to basically live with it, especially with a long time horizon.

- Yeah, I found the stat of 10% of years having a 30% drawdown or worse, I found that pretty surprising. I thought that was more rare than that, but that kind of put it in perspective. - Well, yeah, I still think, I mean, so that's one out of 10 years, though, if you think about it.

- It's true, it's true. But yeah, it just sounds so drastic. But yeah, I guess we had it in just March of 2020, right? - Yeah, so, I mean, we kind of, so there was one in 2007 to 2009, and not quite, you know, 12 years later, we had one again in 2020 or 10, 11 years later.

So, that one actually came kind of right on schedule. But the other thing is, like, the 50% crashes are even more rare, but we had two of those in seven years or eight years to start of the century. So, it's hard to say. But yeah, I think this is just, this is part of investing, unfortunately.

Sometimes you just have to, like, learn to eat your losses, unfortunately. - Yeah, I'm glad I missed those 50% ones. Would have been a good entry, though, right? - Yeah, honestly, the best purchases I ever made were just plowing money into my 401(k) in 2008. I think those are probably the best purchases I'll ever make as an investor.

Okay, let's do the next one. - Okay. So, up next, we have a long one, but a good one. I think it's gonna need some clarification, but on some of these acronyms, especially. I wanted to email you about paying off a mortgage early when you have kids entering college.

I've been considering paying my 3.25% mortgage off early as I have children entering college and I'll have them in college for at least 10 years straight. I report assets for FAFSA starting next year and have been thinking about my expected family contribution. I've been thinking of a mortgage payoff as a return of 8.25%, which is very solid historically.

I would have to sell stock to make this move, but should be able to minimize the taxes. Am I making too much of the expected family contribution, EFC, number on the FAFSA? Could you ask your college savings expert how important, to the bottom line, the EFC is? I don't understand much of that question, I have to be honest, so I hope you can explain.

- I think I can walk it. So, the thing is, so this guy said he's got 10 years straight of putting his kids through college, and I thought, oh man, that's tough. But then I realized my daughter is seven and my twins are four, so I'm gonna have eight straight years of putting kids through college.

Jeez. So, honestly, a lot of this stuff is kind of foreign to me 'cause I haven't got there yet. But we do actually have a college saving expert on our team, Tony Isola, who is one of our financial advisors and specializes in this. Tony himself was a teacher, not in college, but Tony knows all this stuff and helps people and helps some of our clients work through this stuff.

So, Tony, I think the crux of the question here is, when does it make sense to sort of move some of your assets around? And is paying off your house a good idea if you don't want it to come up on your financial aid package? 'Cause I guess the idea is certain assets can count for you or against you when you're trying to apply for financial aid.

So what do people need to know here? - Well, I think what people need to know, I think we need to start from the beginning, right? Like, think about what's going on here. People are making this huge investment, the biggest investment they're gonna make other than purchasing a home.

And in the end, they're not gonna know what the price is gonna be. You're gonna apply to college and you have no idea what you're gonna end up paying. That's number one. Number two, you don't really have anybody to help you. Even in the CFP curriculum, only one, I think it's like two pages cover paying for college.

So that's for a CFP. Your college guidance counselor, okay, doesn't even have to take a course in financing college. They know nothing about this. So it's a wonder, like, this is like a really more in-depth question, but most people just don't have any clue where to begin. And that's the reason why there's a trillion dollars in student debt, okay?

- So I guess if you're a parent trying to plan for this, when does it, like, it sounds like someone's like trying to hide assets in a Cayman Island offshore account or something, like, what can you actually do that can help you, or is it just context dependent? - It's context dependent, because let's talk about this question.

There's so many nuances here. If you're applying to a public college, right, they don't count your home equity. So it might make sense to take some of your cash, which they're gonna count that a little over 5%, and use it to pay off your mortgage. Okay, let's go to scenario two.

If you're applying to a more expensive private college, many of them use your home equity. So let's say you apply to a place like, say, Northwestern. They will take 5% of your home equity and count it towards you being able to afford college. So if you have $500,000 in home equity, they're saying, you know what, nevermind all the other money you might have, we're gonna count $25,000 right off the top towards you, you know, that you need to contribute.

Like, they're expecting, this is how crazy the system is. - So they're effectively saying, like, you should be able to take that 25 out of your house and spend it on college. - You got it, in addition to other loans. But I mean, the school costs like 80 grand a year, so there's all kinds of things going on there.

But my point is what the guy, he's asking like a really good question, but it depends. And I also think that there are many, again, the financial service industry, for the most part, is just not the most moral place in the world, you know, as we all know. And you have people out there really not knowing college planning, and all they're telling you is how to hide assets, where that's not really where you should be looking, okay?

You should be looking at the colleges and looking at colleges who are willing to give you money to go there. And that's really a much better plan. - It sounds like it matters, like, are you sending your kids to a public or a private school? That's kind of like the first question, correct?

- Yep, it's very important, because you could go to a very good, like, for instance, where you are in Michigan. Like, if you live in Michigan, there's one price. If you live outside of Michigan, and you're like, I wanna go to Michigan or Michigan State and sit in the crowd with 110,000 screaming lunatics, and, you know, have all this stuff, you're gonna be paying a lot more.

So you need to know what's going on. Like, do you wanna pay more to go to a state school, where you can go, like, to a school in your own state for maybe half the price, right? So there's lots, there's so many things. I think if we could bring up that, the first chart, where it shows the sticker price and the net price, this is what's going on here.

Like, you're kind of, to pay the full price in college is just silly. - This one kind of blows my mind, because people think that college is so ridiculously expensive, but to your point, like, the majority of people aren't paying that actual sticker price because either a financial aid or some sort of ability to negotiate, right?

- Right, right. Like, here's the deal. Basically, most schools, other than maybe the top 1%, have trouble filling their freshman class. And what they wanna do is offer you, they call it merit aid, it's really a discount. So it's almost like, you know, they charge you a lot, and then they know they're gonna cut the price.

So people, it makes people feel good. It's almost like bait and switch, right? - It's like JCPenney, like, everything was on sale all the time. - Right, right. So they're like, okay, it costs 80 grand to go here, but you know, you're probably gonna, you know, they know in the end you're probably gonna end up paying, you know, 30 or 40, and then the people who get that feel really good, right?

'Cause it's like, oh, we got a scholarship or whatever they're gonna call it, but in all, in reality, it's more of a discount, and it's kind of a game. And every year, this game changes. They look for different things. So I'll give you a hint for your readers, for your listeners.

Most kids, 90, over 90% of kids go to college within 500 miles of where they live, right? So just by applying to a college that's further away, you're probably gonna get more of a break because the schools wanna have diversity, say, in their student body. So you're gonna be a better candidate.

Like, you might have the same grades as someone from that state, but they're probably gonna look at you differently 'cause they're like, hey, we wanna have a representative from New York or Connecticut. - So I guess instead of trying to figure out some way to beat the system and move your assets around, it's more important to have a discussion with your children about, where do you wanna go to school?

And then let's target a strategy to that specific school instead of trying to game the system somehow. - Totally right. And let's take a look at that second chart with the map. Most people, too many people don't even fill out the federal financial aid form. And it's just silly because some schools actually use that form to provide merit scholarships.

A few, not too many. But the other thing about the financial aid form is you cannot get the best student loans, which is the federal direct student loans if you don't fill out the financial aid form. They have the lowest interest rates. They tend to have, they definitely have the best terms.

And if you don't fill out the financial aid form, you're not eligible for them. And a second thing is like, again, these are simple things, like just fill out the form. You might not be eligible for financial aid, but say you lose your job and some bad things happen in your family.

If you didn't fill out the financial aid form, you're not eligible now to like appeal and say, hey, look, my situation changed. What can be done? So it's like a no brainer to fill it out. - So this is obviously something people don't go through very often. Obviously this guy is with 10 years of colleges.

I think this price, the price you pay for college by Ron Lieber, it's probably a good starting point for a lot of people because this is a very complicated process and they don't make it easy for people. So that's probably the first place to start. All right, so Tony, thanks for that one.

Let's go on to the next question, guys. - Okay, so next up, another Michigan one. Hi, Ben, longtime listener from Grand Rapids. I'm thinking about opening a savings account for my kids who are one and three years old. We already have a 529 for each of them. What's the best tax advantage account?

Custodial brokerage, trust fund? Would love to hear your thoughts. - If you think mentioning my hometown is going to get people to get their question on the show, then you are absolutely correct. I'm just kidding. So when my kids were born, I opened a 529 and all their names, started funding it right away.

But I also had this idea a few years later of, well, eventually when these kids are older and they're going off to college or don't have high school and wanna do something with their life, they're gonna need some money for a down payment for their first house or a wedding or maybe just a deposit for their first apartment.

So I said, I wanna start an account for them. So I just did it through our Simple Liftoff program with Betterment. And through that, you can open one account and then you can fund each different goal. And I just named each goal for one of my kids. So I did that.

Tony, what are some other things you can do? Because I know, unfortunately, you can't really open a Roth IRA in your kid's name if they don't have any earned income, but what are some other ways you can do this? Well, I think you can't open, say, the Roth IRA in your kid's name, but you could certainly fund it and give them the money each year when they need it.

I think it's now at $16,000 a year that you can give out, and you could give more. So I guess having it in their name is not that big of a deal if you're gonna give it to 'em anyway, right? No, and I really like the idea of the Roth because it's like a flexibility thing, right?

Like if the kids don't need the money, you now have this extra retirement money that you're going to get. You know, it's gonna grow tax-free, and you're gonna be able to withdraw it tax-free. So I really like, as a secondary option, to the 529 is the Roth IRA. Even though it's not in the kid's name, there's no law that says you can't take any of the principal you put in over the year and no tax consequences, give it to your children.

So that's a big thing. And I think if we look at the other, the total savings chart that I had given out, it's unfortunate, but many people, like here's how we pay for college. I think 529s are by far the best way. But you see, many people don't even know what a 529 is, and there's a lot of misinformation.

Oh, what happens if my kid doesn't go to college? Well, first of all, you know, you can use it for trade school. You could use it for anything that's eligible for federal loans. So if your child wants to be a chef or an electrician or a plumber, you can use 529.

- Well then, worst case scenario, you just end up paying the taxes after the fact, right? - Yeah, and all you do is pay taxes on the earnings, right? Whatever you, it's just the earnings. And most people, let's look at, you know, the next chart. What do people have saved?

Like, what are you really worried about? You know, like the average person has saved, that's one year of public school, right? A private school tends to cost between, you know, 60 and $80,000 a year. So a public school, you know, tends to cost between like maybe 22 to 27.

So, you know, people are like worrying about these things that like they're gonna have like millions of dollars in this account, like, you know, like you said, Ben. Secondly, you can change the beneficiary. So you can use that money yourself if you want it to further your education, or if your kids have kids, your grandchildren, you could use it for them.

So I really don't see how people get these insane ideas that if you fund the 529 plan, there's going to be no use for the money. And like I said, it's not like they're putting in like $200,000 a year. What the average person is probably putting in $100, $200 a month, right?

- Good point. - Yeah, I think 529s are, I was just gonna say, they seem way more versatile than I think a lot of people, like Tony's saying, think. A lot of people, I think, think that it's only for like a four-year university and, you know, that kind of thing.

- And it's graduate school. Graduate school too, 'cause then people are like, well, what happens if we get a full scholarship? Again, like 1% of the people get full scholarship, right? They always come up with crazy scenarios. - That's a good problem to have, right? - Of course, it's a good problem.

And how about this, let's take this one step further. If you're that smart that you're gonna get a full scholarship, right? You're probably gonna go to graduate school, don't you think? Like law school or medical school. - It's like it is a fact, yeah. - And now you use it for that.

And they don't give out scholarships for the most part like they would in, you know, in a four-year school, in graduate school. It's much harder to come by the money. So again, it's like, you know, people just say, they just say crap that's just not true. You know, they tell people don't fill out the financial aid form, don't put, you know, like there's just so much misinformation that's out there.

This is why we have a disaster, quite frankly, with people paying for college because they don't have the right expectations. And then there's the guilt factor. Oh, my son or daughter got into Cornell or something. We didn't really save enough, but we're not eligible for aid 'cause we're kind of middle-class.

So now we're on the hook for $320,000 a year. And no one thought about like that. What happens if they get in and we get nothing? You understand? So like we have major situations here where people end up spending enormous amounts of money they don't have, so they have to borrow because they didn't set the proper expectations.

That's what we try to do. Like when we talk to clients and stuff and tell them, look, here's, you need to know this before you apply what you're gonna end up spending. But the problem is like, I have software, I have all kinds of tools to do this. The average person is like, is completely unarmed.

- Yeah, and if anyone wants to check it out, go to tonyisola.com. That's his blog, A Teachable Moment. Find his email there and shoot him an email. I'm sure he will be happy to answer your questions. - Yeah, sure. Any questions you might have, absolutely. - And Tony, I do see you have a Giants sweatshirt on there.

- Yes, I do. - I just wanna say, I'm kind of sick of you New Yorkers complaining about the Giants. You've won two Super Bowls in the last like 15 years. - Oh, yes. - The Lions are the worst professionally run organization in the world. I'm sick of hearing you Giants fans complain.

You won two Super Bowls in the last 15 years and we've won one playoff game in the last 40. - Yes, but on the other hand, the Lions were like the 86 Bears this year compared to the Giants. So we have to look at the recency effect also is in play.

So there's always that going on. - If you have some thoughts about any of the stuff we talked about today, Tony's 529 stuff. Tony is very pumped up about this, if you can't tell. Leave some comments, let us know what you think. Question for the show, email us, askthecompoundshow@gmail.com.

Remember to subscribe, like, all that good stuff. Shop, what's our shop called? idontshop.com.com. - idontshop, yeah. - You can get a Ben doesn't drink coffee mug there, which is still true, I still don't drink coffee. And we will see you next week. - See you, everyone. (upbeat music) (upbeat music) (upbeat music) (upbeat music) (upbeat music)