A lot of comparisons have been made between the current Global Financial Crisis and the great depression, and indeed there are many similarities. Unfortunately though, such comparisons seem to provide little scope for optimism, especially for the longer term investor. After all, anyone who bought prior to the crash in October of 1929 would have had to wait 25 years before their capital was recovered!
Similarly long periods are quoted for more recent market crashes, such as the 1987 crash where it took 9 years for new highs to be created. So there is little reason to think that even if the market is close to the bottom, we will see a swift return to 2007 levels. But does this mean that people who were invested in the market prior to this most recent correction should abandon all hope?
The long recovery periods that are quoted assume that all your capital is invested at the absolute high of the market. For those who had been regularly contributing to their positions in the years prior to the crash, their breakeven point will be well below that of the market high. This is because a significant run up is usually seen in the lead up to a crash. In the case of the Great Depression, the Dow advanced 244% in the 5 years prior to the crash, and 54% in the year prior. An investor who had been regularly adding $1,000 to their portfolio each quarter for 5 years prior to the crash would have seen their invested capital recover in just 7 years instead of 25. This still isn’t fantastic, but it’s a significant improvement in recovery time.
Continued investment following the crash helps improve the situation further still. In the above example, had the investor continued adding $1000 each quarter, they would have seen a 42% return on invested capital over the same period. This is because we tend to see substantial gains from the low of the market. Following the low of 1932, the Dow rallied 63% in just one year. The annualized growth over the next 4 years was a massive 31%.
Professor Jeremy Siegel, a noted expert in financial markets, has conducted some interesting research in this area. He has demonstrated that for the 7 largest corrections over the past 145 years, the market showed an average improvement of 24% in the year following the crash.Moreover, he noted that there was an observed 21.4% improvement per year over the next 3 years, and 18.4% per year over the next 5 years. Clearly, it pays to invest into the markets following a large correction.
The worst thing investors could do at this point is to pull up stumps and walk away from the market. Indeed, investors should be looking to add to their portfolios, average down their entry prices and position themselves for recovery. It may well take the market 10 years to get back to 2007 levels, but that doesn’t mean you have to wait that long.
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