If you invest in stocks, mutual funds, or ETFs, you probably are well aware that we have experienced a very long run of rising stock markets. Everyone wants to know, is this the end of the business cycle? Is the bull run losing steam? When will the crash come? We would all like to know whether we should continue to invest in stocks, or will the market crash.
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Who asked the Question
In my “day job” as an economist, I frequently attend speaking events. At a recent luncheon, one of the attendees – “James”, roughly age 30 – stayed late to ask the speaker whether he should continue to invest in equities or will the stock market crash. Clearly no one has their crystal ball polished enough to be able to answer that question. But to be fair to James, the speaker was a senior policy advisor from the Bank of Canada. Perhaps he might have had an inkling of future monetary policy and how that would affect stock markets.
The speaker declined to answer the question, of course. But as a personal finance blogger, I was quite interested in James’ question, and he and I continued the conversation.
My short advice to him was that if he is investing for retirement, he should go more risky. If he’s saving up to buy a house, he should not. He said he was doing both. But – and I think this is something we can all identify with – he didn’t want to “leave any money on the table” by pulling out of the stock market now if it is still going up.
Stock Market 2008 to 2020
Many investors are feeling a bit edgy about the stock markets because they have been rising a long time. The following stock market graph shows the rise in the TSX (Toronto Stock Exchange) and the S&P500 between 2008 and 2019.
While the graph shows some ups-and-downs for the TSX and the S&P, overall they both have been rising for many years. The last big downturn was in 2008. To some extent it just felt like “we were due” for a correction. In 2008, the TSX lost 35% of its value, so it’s natural to be concerned for your nest egg. At the same time, if you had pulled out of the stock market at the end of 2018 when prices started to drop, you would have missed out on a great year in 2019.
Will the Stock Market Crash?
Check out this stock market graph of 2020.
Stock markets around the world fell dramatically.
But let’s put this in perspective. Was this a BIG stock market crash?
Remember the final three months of 2018? Look at how far the stock market index fell then! The TSX fell about 13%, and the S&P fell about 14% before the end of 2018.
But those were followed by some incredible gains throughout all of 2019. Over about 12 months, the TSX grew over 20%, and the S&P grew a whopping 29%!
Certainly most people don’t like to see the value of their portfolios fall like this! There are a few who look at this as “stocks are going on sale” and rush in to buy more. There is absolutely some truth to this! If you were going to invest $1,000 in stocks that used to cost $50, you would have purchased 20 shares. If they now cost $40, your $1,000 can now get you 25 shares.
What the Experts were Predicting in 2019
A recent article from Investopedia tried to address the question of a stock market crash, with Why Stocks Will Plunge 18% by Year-End Despite Fed Rate Cuts.
The Motley Fool writes, 3 reasons we could see a stock market crash in 2020.
Economy and Markets published The Great Crash Begins in 2020, based on 10-year, 20-year, and 40-year cycles.
On the other hand, the International Monetary Fund has done a long-term comprehensive look at How Well Do Economists Forecast Recessions? Spoiler alert: the answer is quite poorly. They looked at 153 recessions in 63 countries, and found that economists only predicted 5 by the preceding April. Even then, they underestimated the extent of the recession.
Money Crashers writes 8 Reasons Why You Shouldn’t Try to Time the Market – What to Do Instead. This was essentially my advice to James about not trying to time the market.
Invest for Goals; Don’t try to Time the Market
The most important part of investing, in my opinion, is knowing what your goals are for the money you are putting away. If you’re 30-ish, like James, and you’re saving for retirement, you have decades to go. You want to be more aggressive for long-term growth. Yes, you will face stock market crashes within that time. And it will be heartbreaking to see your portfolio dropping. But just keep putting money aside and buying more stocks at whatever the current price is. Logically, we know stock markets always increase given enough time.
If you are saving for a downpayment on a home, then you should likely be much less aggressive in your investments. How would you feel if your hard-earned downpayment dropped by 30% the year before you planned to buy a house? It can take several years for stock markets to regain those losses. And housing prices may continue to rise even during a stock crash.
For parents who are putting funds aside for their children’s education funds, again you must consider the time horizon. If they are in elementary school, you have many years for the fund to recover if there is a market downturn. On the other hand, as they go through high school you’ll want to lock in the gains you’ve made so far. You really can’t ask your son or daughter to delay university for a few years simply because their education fund has lost value. So you’ll be forced to sell those stocks in a down market. This is not a good position to be in.
It’s true, what James feared. If you pull out of the market because your time horizon is short, you might be leaving money on the table. You might have been financially better off to stay in stocks. Unfortunately you only know that after the fact, since most of us have a very hazy crystal ball.
Don’t hold more stocks in a bull market than you would be comfortable holding during a bear market. The reason they’re called market crashes is because they can happen quickly and without warning.Ben Carlson in Fortune, Sept. 6, 2019
How to Invest for your Goals
There are some common rules of thumb for investing for your long-term retirement savings.
100 Minus your Age
Traditionally, advisors recommended you subtract your age from 100, and that’s the amount you invest in stocks. The remaining would be in fixed income, such as bonds, GICs, cash, etc.
For example, a 30 year old like James might invest 70% in a stock market index ETF fund or dividend growth stocks, and 30% in a bond ETF fund.
This is now seen to be too conservative, and this rule has often been adjusted to the following.
120 Minus your Age
Similar to above, but now you subtract your age from 120. James would now invest (120 – 30 = 90) 90% of his portfolio in a stock market index ETF fund, and only 10% in a bond ETF fund.
A recent article from MoneySense.ca discusses both of these asset allocation rules, but also points out that how much you contribute to your retirement account is ultimately much more important than your percent in equities versus fixed income. More important than rules, is your own tolerance for risk. If a large decline in the value of your retirement fund would keep you wake at night, then consider having less invested in equity regardless of what the rules of thumb say.
It’s more important not to buy stocks when prices are high, and then sell when they drop because you’re getting cold feet.
If you plan to spend these funds within the next 5 years, they should be mostly or entirely out of the stock market. For my children’s education funds, by the middle of high school they were completely in GICs. I had locked in all the stock market capital gains and dividends they had received. Did I miss out on some stock market gains? To be truthful, the Toronto Stock Exchange Index fell shortly after I sold the last of my eldest’s stocks. That felt really good, actually, that I had done the right thing. It was temporary, and the index came up again, though.ADD_THIS_TEXT
Keep in mind, you don’t have to have the MOST you could possibly make; you just need ENOUGH. It is truly impossible to time the market so that you sell on exactly the day with the highest return before the fall. If losing 30% of your investment would severely impact your plans for that money, then it’s time to pull back and be more conservative.
What to Invest in
I recommend investing in index ETFs – that’s short for Exchange Traded Funds. The brightest minds in financial investing spend their whole lives analyzing stocks and bonds and trying to pick the winners. And they’re wrong more often than right. So don’t waste your valuable time and effort trying to pick individual stocks.
What I personally do as a Canadian, and what I recommend, is to start with an index fund for the Toronto Stock Exchange, and another for a bond fund. When you have a bit more money, add in a world excluding Canada index fund. I mainly use iShares ETFs, because they have very low management fees.
|iShares ETF Name||Ticker Symbol|
|iShares Core S&P/TSX Capped Composite Index ETF||XIC|
|iShares Core MSCI All Country World ex Canada Index ETF||XAW|
|iShares Core Canadian Universe Bond Index ETF||XBB|
I like Questrade, because they give you the ability to buy and sell ETFs for free! I have had self-directed investment funds at two of the major Canadian banks and they both charge about $10 every time you buy or sell ETFs. Free is better!
Should you Change your Investment Strategy for a Potential Stock Market Crash in 2020?
As I originally advised James, invest based on when you need the money and your own risk tolerance. Short term goals need a conservative approach. Long term goals can have more stocks because you have time in the market if there is a bad couple of years. If you’re like James, saving for retirement which is still 30+ years away, and also planning to buy a house in the very near future, this means your asset allocation is different in your two accounts.
Invest for your goals. Trying to time the market just doesn’t work.
Please note that the information here and elsewhere on my blog is for education and entertainment purposes only. Any examples are for demonstration purposes and may not apply to your personal situation.
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All great points. As someone who has a long time before traditional retirement age I prefer the set it and forget it method. Honestly I don’t pay attention to what the stock market is doing in the regular. Every now and then I will check in on my investments but because I don’t intend on using them for awhile I’m not too worried about minor dips and gains.
That’s the right attitude! Mr. Tea and I recently re-evaluated our portfolios to see if we were balanced appropriately given that we’re 10-15 years from retirement. But the conversation was NOT about the stage in the market cycle versus leaving money on the table.