Should Young Investors Really Fear a Market Crash?

The other day I got a tweet from my brother-in-law Brennan (who’s an awesome guy and runs a travel blog if you’d like to check it out, though you should first make sure to hide the women and children).

Anyways, the tweet looked like this:

Fear of market downturn

This is a really important question because it’s the kind of thing many people worry about when they start investing. As my friend Jason writes, the fear of a market crash is a big reason why many people avoid investing altogether, or simply don’t take advantage of it as much as they should.

But there are two very simple assumptions underneath this kind of thinking, both of which need to be challenged:

  1. That a market crash is the biggest thing investors have to fear, and
  2. That you can successfully time your way in and out of the market

We can make quick work of the market timing assumption and will do so below.

As for the 1st assumption, research shows that older investors who are nearing or at retirement age are correct in fearing a market crash first and foremost. Big losses early in retirement can have a significant negative impact on whether their money lasts the rest of their lives.

But for younger investors, the fear of a market crash really needs to be challenged. In fact, the biggest risk we face is not a big market crash, but failing to participate in the big market rallies.

The fear behind market crashes is misguided

For young investors, the primary goal of investing should be growth. We likely don’t yet have the wealth we need for true financial freedom, so our job is to build it.

With that in mind, the focus on market crashes is misguided. It’s not that a market crash can’t hurt, it’s just that it’s not what will hurt the most.

For young investors, the reality is that it’s actually worse to be out of the market when it’s doing well than to be in the market when it’s doing poorly.

The logic is simple. We start with the premise that the market will produce positive returns over the long-term (not a guarantee, but it’s been true so far and otherwise there’s no point to investing at all). With that as our belief, then it leads to the simple truth that the market rallies will be bigger than the market drops.

And if the rallies are bigger than the drops, then the real danger of market timing is in losing out on the growth that those rallies would provide us.

In other words, we can survive the crashes as long as we fully participate in the rallies because the net result will be positive. But once we start missing the rallies, we kill our potential for growth.

And anyways, market timing doesn’t work

I’m going to keep this short and sweet.

There is no credible evidence demonstrating that market timing can be applied consistently and effectively. It doesn’t exist.

Yes, there are examples of successful market timers. There are also examples of lottery winners. The fact that it’s happened to some people through pure chance doesn’t mean it’s a good strategy for anyone else to follow.

On the other hand, there is plenty of evidence showing the very real harm that comes from trying to time the market.

Based on the evidence we have today, the only conclusion we can make is that market timing is only useful if you would like to lower your returns.

How does this information help you invest?

So now we know two things:

  1. It’s more important for young investors to be in during the good markets than out during the bad ones.
  2. It is extremely unlikely that we’ll be able to consistently time our decisions to BOTH get out of the market at the right time AND get back in at the right time (therefore not missing the good markets).

So with those two realities, the only logical course of action is to be in the market all of the time.

That doesn’t mean you choose to be 100% in stocks. It just means that you stick with your desired asset allocation no matter what the market is doing. For me, that means that I’ll keep my portfolio split 70/30 between stocks and bonds whether I think the market is overvalued, undervalued or whatever.

Whatever your strategy, the real key to investment success is applying it consistently. People often feel like they have to “beat the market” in order to be successful, but this is simply not the case (see: Why Do You Have to Beat the Market?).

Stay consistent through the ups and downs, keep contributing, rebalance when things get really out of whack, and you’ll likely find a lot of money in your account at the end of it.

So to answer the two questions that started this conversation:

  1. Is the stock market in a bubble? Honestly, I have no idea and no reliable way to predict it one way or the other.
  2. If so, when do I sell? When you’re ready to retire (or at least semi-retire) and start living off your investments rather than your income. It has nothing to do with what the market is doing.

How do you react to all the market predictions out there? Would you rather be in during the good markets or out during the bad?

**UPDATE: For anyone who wants to hear a REAL example of how you can benefit big-time from this kind of thinking, check out the comment below from Ree Klein. PERFECT example of what I’m talking about here. Thanks Ree for the contribution!

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39 Comments... Read them below or add one of your own
  • Color Me Frugal December 5, 2013

    Sounds like very solid advice. You make an excellent point that for young investors “the reality is that it’s actually worse to be out of the market when it’s doing well than to be in the market when it’s doing poorly.” I’d be curious as to what you think of mass media reports that the events of the Great Recession have scared millennials away from investing in the stock market.

    • Matt @ momanddadmoney December 5, 2013

      I think that like any report, it has some truth to it as well as some over generalization. For those who are fearful, I can certainly understand why given what happened in 2008. I just hope they continue to learn and allow investing to become a part of their financial plan.

  • DC @ Young Adult Money December 5, 2013

    Great advice, Matt. I think it’s so important to make regular, consistent contributions to your retirement account. If you do that over the course of 10, 20, 40 years the ups and downs should even themselves out (in theory).

    • Matt @ momanddadmoney December 5, 2013

      Consistency is such a huge key. That alone can put you well ahead of most investors.

  • Holly Johnson December 5, 2013

    I’m young enough still that I’m not too worried about it. For now we’re just investing regularly and forgetting about it for the most part.

  • John S @ Frugal Rules December 5, 2013

    “Whatever your strategy, the real key to investment success is applying it consistently.” I could not agree more Matt! Sure, someone that is at or near retirement should be somewhat more cautious, depending on their timeline and tolerance of course, but for those that aren’t consistency is going to serve them well. The market will go down, it’s inevitable, but that doesn’t mean it should be avoided all together. That said, I understand the fear, but being out during the good times will only have a disastrous impact on your portfolio if you’re sitting on the sidelines watching it go up.

    • Matt @ momanddadmoney December 5, 2013

      Right on. There’s definitely more sensitivity that needs to be given to older investors, but not in a market-timing more. More in the sense of determining whether they need to keep working, lower spending or whether they already have enough money and can lower their risk even more than they planned. If you’re near retirement and this recent rally has pushed you past your goal, you could very strongly justify a shift to a more conservative strategy, but that would have nothing to do with thinking the market was going to fall. It’s simply good, conservative practice.

  • Laurie @thefrugalfarmer December 5, 2013

    We are eagerly awaiting a market crash so we can plunge thousands of dollars into stocks and other funds. See how much we’ve learned? 🙂

    • Matt @ momanddadmoney December 5, 2013

      Haha, funny how that works! Is your cash available to invest right now and you’re just waiting, or are you talking about money you’ll be getting in the future?

      • theFIREstarter December 27, 2013

        I am exactly the same Laurie… Although I don’t have many investments currently and also not much cash sitting around. But either way you look at it, having a nice big crash right now would be great timing for me to start my (Early) Retirement investing. Not that I’d wish this on anybody else of course!

  • Andrew December 5, 2013

    I decided to sell some of my stocks and moved my deferred compensation plan into a stable fund back right after the 2008 market crash. Bad decision as I missed a portion of the bull market. No more market timing for me…though I might be tempted to plow some more money in if there is another crash. I just can’t help myself sometimes.

    • Matt @ momanddadmoney December 5, 2013

      If the decision was based on a long-term plan, then it wasn’t a bad decision. It might have been unfortunate timing even though it was a good decision based on your goals. But if it was a reaction to the markets, then better to learn the lesson earlier than later!

  • AvgJoeMoney December 5, 2013

    Love it. Consistent investing mixed with a responsible asset allocation creates the best results? In this case boring = just what the doctor ordered.

  • Grayson @ Debt Roundup December 5, 2013

    I plan on sticking in the market if it falls. I really plan on investing more when stocks go down. I can buy more and hold them. The market will come back up. It always goes up and down. Buy low, sell high!

    • Matt @ momanddadmoney December 5, 2013

      So do you have cash on the sidelines specifically marked for when the market falls?

      • Grayson @ Debt Roundup December 5, 2013

        Yes I do!

        • Matt @ momanddadmoney December 5, 2013

          Do you worry at all about that cash being out of the market as it continues to rise? How do you view the tradeoff between potentially missing out on growth vs. potentially missing out on a loss with that money in particular?

          • Grayson @ Debt Roundup December 5, 2013

            No, I keep this cash out for various reasons. The prices of stocks are really high right now and I use this cash to buy severely undervalued stocks. This will be the case when the market goes back down after a correction. Most people agree there will be a correction, but don’t know when or how much. This is when the money will come into play.

          • Matt @ momanddadmoney December 5, 2013

            Interesting. So what’s your criteria for when it’s gone down enough to buy back in?

          • Grayson @ Debt Roundup December 5, 2013

            Well, I am not buying back in. I am continuously investing each and every day. I have not taken money out and I invest my maximum each month. The extra cash I have is just for buying up more stocks when the market falls or for undervalued stocks. I am thinking there will be about a 10-15% correction, so my criteria will be near that.

          • Matt @ momanddadmoney December 5, 2013

            Sorry for all the questions, it’s just interesting to me to hear how people do this. So what is the 10-15% correction from? Is it from the stock market levels today? Or some benchmark established in the past? Or from whatever high we hit in the future? What if the market rises 15% from today and then falls 15% after that? Is that the buy-in point? Whatever your specific system is I’d love to hear it.

          • Grayson @ Debt Roundup December 5, 2013

            I have just been researching and most analysts and others have indicated a possible correction in 2014. Some feel many stocks are overvalued, so they think it is coming. I would probably use this point in time and not if it increases another 15% and then comes back down. I don’t have to use the money to buy up stocks when the market falls. I can still use it to buy undervalued stocks. I don’t think the gains we have seen this pas year are sustainable and most people agree with that statement.

            That being said, it is the stock market. It is extremely hard to predict and I am not going to try.

          • Matt @ momanddadmoney December 5, 2013

            Cool, thanks for the detail. And good luck!

  • Done by Forty December 5, 2013

    “[T]he only conclusion we can make is that market timing is only useful if you would like to lower your returns.” I cracked up at that.

    My dad was asking me whether he could continue to borrow against his 401k (so he can spend it!), since we’re so clearly in a bubble. Maybe I should be sending him to your blog…

  • Ree Klein December 5, 2013

    Matt, your post/advice is right on the money. I’m living proof. As one of your “mature” readers, I have lived through a couple of market downturn doozies. The last one, of course, had the potential to cremate my retirement nest egg.

    While people far smarter than me pulled their money out of the market and STOPPED CONTRIBUTING, I left my investments alone and JACKED UP my contributions to the maximum allowed.

    Did it hurt watching the balances drop each month despite the hefty amounts I was contributing. ABSOLUTELY! But I knew that history was on my side and that if I rode it out things would recover and then some. THEY DID!

    That was the best decision I could have made and it paid off. So for your younger readers, as you say, while there isn’t any guarantee it will work every time, if you start now you’ll have the best chance for long-term success.

    • Matt @ momanddadmoney December 6, 2013

      Great story Ree! I’ve just added an update to the post pointing people to your comment. Thanks for sharing!

      • Ree Klein December 6, 2013

        Awesome! I hope my story underscores your great advice and encourages people to stay the course and see the “sale” when the next dip shows up…and it will 🙂

  • PFUtopia December 5, 2013

    I believe a lot of the concern about “getting into or out of the market” is perpetuated by the financial media. Everyday there is a story about the next epic collapse or the next historic rally. The so called experts weigh in and one’s opinion varies from the next. In the end, if you are investing over the long term horizon (such as for retirement), downturns can actually be beneficial! Buy low, sell high, right? Just keep investing in regular intervals and don’t sweat things.

    • Matt @ momanddadmoney December 6, 2013

      I agree. The financial media has a lot to do with this kind of thinking. It would be pretty tough to panic sell if we weren’t constantly inundated with the notion that maybe we should be panicking.

  • Jacob @ iHeartBudgets December 6, 2013

    So, you don’t suggest adjusting more conservatively if the market starts to plummet? Or is that the same thing as market timing?

    • Matt @ momanddadmoney December 6, 2013

      I think that has to be considered market timing. You’re changing your investment strategy based on what the market is currently doing (or what you expect it to continue doing over the short-term). How would you view it?

  • Derek Chamberlain December 10, 2013

    I’ve killed myself over the past 6 years trying to time the market. If I would have simply followed half of the advice here, I’d probably be able to retire 5-6 years earlier – ugh!!!! At least you live and learn 🙂

    • Matt @ momanddadmoney December 12, 2013

      Live and learn is right! The best thing you can possibly do is use the past to make better decisions in the future. Sounds like you’re doing just that.

  • Matt @ momanddadmoney December 12, 2013

    Just goes to show, you can always find an opinion in every direction. Thanks for sharing.

  • MoneySmartGuides December 18, 2013

    Timing the market never works. It’s best just to accept that downturns will happen and prepare yourself mentally for them and the media over-hyping them.

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