New investors worry about buying just before a market crash. Don’t we all. But long-term wealth accumulators benefit from temporary downturns.
The internet bubble burst back in 2000 when Nortel faltered. The S&P/TSX Composite Index (a reasonable measure of the overall Canadian stock market) peaked in August, 2000, based on month-end data, including dividend reinvestment. It proceeded to tumble 43 per cent before hitting a low at the end of September, 2002.
An investor who put all of their money into the stock index at the 2000 high (while reinvesting their dividends and not making further contributions) would have generated average annual returns of 4.4 per cent through to the end of January, 2019. On the other hand, an investor who went all-in at the 2002 low would have seen their portfolio rise at an 8.7-per-cent annual rate by the end of January, 2019. (Fees, taxes, inflation and trading frictions are not included in the returns herein.)
By way of comparison, bond investors enjoyed relatively steady advances based on the returns of the S&P Canadian Aggregate Bond Total Return Index. The bond index climbed at a 5-per-cent annual rate from August, 2000, to January, 2019, and it advanced at a 4.7-per-cent annual rate from September, 2002, to January, 2019.
The stock index lagged the bond index from the highs of 2000 by an average of 0.6 of a percentage point annually through to the end of last month. It beat the bond index from the lows of 2002 by an average of four percentage points annually.
Most investors don’t invest all at once. They slowly build their portfolios over many years before retiring when they start to take money out. The steady inflow of money changes the return math.
The accompanying figure shows the returns of four portfolios. The first two start at the peak of August, 2000, with one investing in the stock index and other in the bond index. The remaining two start after a 25-month delay at the stock market lows in September, 2002. In all cases $1,000 was added to the portfolios each month through to the end of January, 2019.
The stock investor who started at the 2000 high wound up with a portfolio worth $422,000 (rounded to the nearest $1,000) by the end of January, 2019. The bond investor got $334,000 over the same period. The stock portfolio was 26 per cent larger than the bond portfolio.
While the bond index beat the stock index from the peak in 2000, the stock portfolio with monthly contributions won the race against the bond portfolio over the same period. The potentially puzzling difference was due to the timing of the purchases. The stock accumulator was able to buy when stocks were temporarily depressed during the market downturns while bonds climbed more smoothly and didn’t offer similarly stellar buying opportunities.
The stock portfolio that started at the market lows of 2002 grew to $344,000 by the end of January, 2019. The bond portfolio grew to $276,000 over the same period. In this case, the stock portfolio provided 25 per cent more than the bond portfolio.
Investors who started at the peak in 2000 added $25,000 to their portfolios by the time the stock market hit its low in 2002 when the other pair of investors got their start. The extra money invested on the way down led to a difference of $78,000 in the value of the stock portfolios by the end of January, 2019.
Starting at the market peak in 2000 didn’t result in disaster for diligent savers. Instead, they were able to buy more when the market was low and profited over the long term. Young accumulators who fret about investing at a peak should remember they’ll be buying more for years to come.
Norman Rothery, PhD, CFA, is the founder of StingyInvestor.com.
Norman Rothery