One of the most common questions I received from readers is:
Is it better to invest more Money after the market downturn?
For example, if you originally invested $500 per month, should you double it to $1,000 per month once the market drops 20%, 30%, etc.?
Logically, this seems to make sense. After all, most market drops are short-lived, so buying after a dip is the same as buying at a temporary discount, right? Can’t you love him?
Unfortunately, only the data seems to agree in the extreme. For example, going back to 1926, it appears that future returns increase only during the largest declines (40% or more). We can see this by examining the one-, three-, and five-year future annual returns of the S&P 500 broken down by level of drawdown (i.e., the percentage of all time-highs):
As you can see, the average annual returns for one, three and five years when the market is down >20% or >30% are almost identical to the returns over all months. This indicates that there is no additional benefit to increasing the investment during withdrawals of this size.
However, once the market drops 40% (or more) from all-time highs, everything changes. At this point, the benefit of doubling seems to be pretty great. In particular, after a drop of +40%, the S&P 500 tends to return 25%. Over the next year Compared to 13% (across all months) and 12.8% annually Over the next five years Compared to 11.1% (across all months). This suggests that there is a lot of benefit from “buying the dip” during the biggest pullbacks.
But, we should probably use a time period more comparable to the modern era. Although I regularly rely on data going back to the 1920s, some have argued that this data is not helpful given how much the US stock market has changed since then. I see their point. So, I did the same analysis as above, except this time the data started in 1988 (I’ll explain why I chose 1988 in a moment).
Starting in 1988, we can see that there is now the benefit of investing in the S&P 500 after a 30% (or greater) decline as well as the benefit of investing after a 40% (or greater) decline:
In fact, after a 30% drop since 1988, the S&P 500 is back 20%. Over the next year Compared to 14% (across all months) and 12.4% annually Over the next five years Compared to 11.7% (across all months). This suggests that there may be some short/medium-term benefits of investing more after the 30%+ dips, but who knows? After all, a limited period of time from a single stock market doesn’t seem like enough data to decide whether we should invest more after a market downturn.
Therefore, I also performed the same analysis on the All Country World Except for the United States (“ACWI ex US”) index beginning in 1988, when ACWI data outside the United States began. Based on the data below, it appears that the benefit of investing after a drop in international stocks is even greater than that of the United States:
You see, across all regression thresholds tested, future returns over the next year, three, and five years are higher than they have been over all other months. If anything, it is that buying on the dip in international stocks has been better than buying on the dip in the US since the late 1980s.
Looking at the information above, investing more after a market drop (especially a big drop) seems like a no-brainer. I do not disagree with the data. However, there is one major problem this strategy fails to address.
The problem of investing “more” after the market downturn
We have shown thus far that future returns tend to be higher after a larger market decline. This means that we must invest more Money when the markets are in turmoil. But, as logical as this strategy sounds, it has one fatal flaw – it generates money out of thin air. Let me explain.
Let’s go back to the example at the beginning of this article and assume that you invest $500 per month in the S&P 500. Also suppose that if the market drops 40%, you will double your contributions and invest $1,000 per month from now on. My question is: Where do you get that extra $500 a month?
Do you invoke it with a spell? Do you print it at home? Do you lift it from Friends and family?
Jokes aside, this is the core issue of the “invest more during rejections” strategy. Money must be on the sidelines waiting to be invested in order to succeed. However, as I explained before (see over hereAnd the over here, and ch. 14 of Just keep buying), this will result in less money Most of the time.
You might argue that you don’t have to have “cash on the margins” because you can only cut back on your spending or increase your income once the market is down. Yes that’s right. However, I would be against it if you can lower your spending or increase your income sometime in the futureThen you can do the same Immediately While that.
After all, why not make those changes now and start investing that extra money today? Statistically, you’ll be better off about 80% of the time and won’t have to wait for a dip in the future either. Of course, this doesn’t sound as good as investing during a “generational buying opportunity” or telling your friends you “bought the dip,” but you can’t have everything.
No matter what you decide to do, increasing your contributions after a sharp market drop is likely to be more beneficial than buying during normal times. However, don’t forget that if you can find extra cash while being rejected, you will likely find that extra cash now as well.
Happy investment and thanks for reading!
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This is function 312. Any code associated with this post can be found here with the same numbering: https://github.com/nmaggiulli/of-dollars-and-data