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What
were you doing and feeling during the 1987 stock-market
crash, which will be 20 years ago this week?
Having
married just two weeks prior, I was about a year into a
great new job. When I saw the biggest one-day percentage
loss in the Dow Jones Industrial Average on October 19
and the near-meltdown that followed, I froze. I didn’t
call my mutual-fund companies or broker. I stayed in
stocks, where almost all of my meager wealth was
invested.
It turns
out my passivity was the best course. I didn’t need that
money for a while and knew the economy was basically
solid. Yet I’m not confusing mettle with foresight. I
had no idea what was going to happen after the Dow took
a 508-point freefall and about $1 trillion evaporated in
a single day.
Various
malefactors have been blamed from a ballooning trade
deficit to program trading. To understand the lessons of
1987, you need to dispense with the mountains of studies
that have been done over the past two decades.
What’s
most important is how focusing on building personal
prosperity will keep you in the eye of any market storm.
To get an idea of how to survive a panic, you need to
know what didn’t happen.
Then and
now
While
the end of October 1987 was a stunning glimpse into the
abyss of fear, the Standard & Poor’s (S&P) 500 Index was
up 2 percent for the year.
Did a
long-term bear market ensue? The following year, the S&P
rose more than 16 percent, if you include reinvested
dividends. From the end of 1987 through 1993, the index
more than doubled in value.
The blip
of Black Monday did little to slow down the US economy.
Banks didn’t close. No depression followed. Businesses
invested in new technologies that would increase
productivity and create jobs. The cyber-tech age was in
full bloom.
The
difference between 1987 and today is that many
institutional safeguards are in place that will curb
market freefalls and ensure liquidity. Yet it’s never
enough with little-monitored hedge funds playing a large
part in trading. There also still needs to be a single
agency policing securities, futures and options markets.
No regulator will be able to prevent crashes or
prolonged declines. Yet there’s much you can do to
shield your money.
Personal-portfolio insurance
When
noting the role of the individual investor in market
selloffs, William Brodsky, the chief executive officer
of the Chicago Board Options Exchange, said individuals
may think, “I’m in for five to 10 years, and I’m not
going to sell my index mutual funds or IRAs.’’
Brodsky
described my mindset 20 years ago—and today. As
president of the Chicago Mercantile Exchange at the time
of the 1987 meltdown, he said the week following Black
Monday was “analogous to a tornado. We saw it coming.”
Brodsky was speaking at a symposium on October 9 in
Chicago.
There
will be more crashes and bear markets. That’s the nature
of capitalism. The question is: How do you keep your
cool? When do you stay in and when do you bail?
Whatever
happens, the chances are good that you will time any
exit or entrance poorly. What if you stayed out of the
market in 1988 or the half-decade following the crash?
Look at the returns you would have missed.
Personal
time-horizon planning is critical. If you can afford to
take a 20- percent loss, how much time would you have to
make up the shortfall?
Risk
management
Fear of
loss is a powerful motivator in investing, although
investors often focus too much on returns and don’t pay
enough attention to managing risk.
Let’s
say you learned well from the crash of 1987 and decided
to invest across three different asset classes that
typically don’t move in lockstep with each other.
When the
dot-com bubble burst, for example, you would have fared
better if you followed this strategy. From March 24,
2000, to October 9, 2002, your big-stock stake would
have been down about 47 percent in the Vanguard 500
Index Fund, which tracks the S&P index.
Had you
diversified, your stock losses would have been offset by
a 26 percent return from US bonds, using the Vanguard
Total Bond Market Index Fund as a proxy.
Adding
icing to the cake would be a 32-percent gain in
real-estate investment trusts (REITs), as represented by
the Vanguard REIT Index Fund. I use these funds because
they are low-cost, diversified ways of investing in
these asset classes. I own the REIT and bond funds in my
retirement accounts.
Even if
you put all of your money on large companies—and stayed
invested from the beginning of the Internet crash in
March 2000 through October 5 this year—your holdings
would have grown 12 percent over that period in the
Vanguard 500 fund.
Focus on
goals
You can
torture yourself trying to explain why markets rise and
fall every day. Don’t trouble yourself. It’s mostly
noise.
Instead,
concentrate on your life plan. Are you saving for a home
down payment? Do you need money for college? Will a
parent need your financial support? Are you planning to
leave the work force part-time or permanently soon? What
if you are disabled and can’t work?
You need
to weigh your own life needs to ensure that you won’t be
devastated by what markets do in any particular time
period. That means protecting against inflation, loss of
future income and the ravages of bear markets.
Where
are you now and how do you get to where you want to be?
It may not matter where you were or what you did 20
years ago. The past is always prologue, yet you need to
create your own portfolio insurance to make that next
crash insignificant. |
