Their greatest asset is time on their side.
For those under 40, memories of March 2000 are more likely to be centered around Backstreet Boys than the Nasdaq-100 Composite (NDX). The tech index set another all-time high and promptly lost roughly 10% of its value by the end of the month. By December of that year, it would lose 50% of its peak.
Regardless of what people remember about that time, no one could know that the Great Recession would hamper the index’s recovery or that it would take about 15 years to recover fully.
The recent 25% Nasdaq correction and its impact on 401ks hits closer to home. While young investors are working on growing their wealth, they lack the benefit of prior experiences weathering a large market correction with a significant amount of skin in the game.
The fear may be compounded by approaching life milestones like purchasing a house, starting a family, or thinking about retirement.
Many are asking questions like, “How much worse can it get?”, “Should I stop contributing to my retirement plan in the short term?” or “When will I make my money back?”.
Unfortunately, no one can definitively answer those questions. However, some of the worst market crashes in American history shed a positive light on the long-term prospects for 401k accounts.
Inside the numbers
Starting with five* of the worst market crashes over the last 100 years, we chose an appropriate comparison index to find a worst-case scenario. (Table 1)
This was done by considering the availability of historic weekly index prices and which indexes were impacted the most severely. We assumed that the investor made their initial investment the week coinciding with the market’s all-time high before the crash.
- Model A tracks how long it took the index to recover its losses for the first time, assuming that no additional investments were made.
- Model B assumes a standard 401(k) contribution plan not accounting for annual raises or any employer match.
- Model C assumes a standard 401(k) contribution plan but with the added benefit of an employer match.
In models B and C, we assumed that 6% of the employee’s paycheck is invested into the index at the current price every two weeks. Savvier investors may recognize this as dollar-cost averaging; this is an investment strategy where one invests a set dollar amount into the market regularly, regardless of market conditions.
In model C, we assumed a 100% match, where the employer matches the dollar amount of the employee’s contribution.
In models B and C, we note the date when the investor last recognizes a loss on their contribution prior to the index first recovering its losses. This is referred to as the “out of the woods” point. Additionally, we note the maximum percentage loss of each model.
Lastly, for models B and C, we note the performance of the 401k portfolios, based on the employee’s contributions, at the date when the index first recovered its losses. **
The results
Across the five market crashes analyzed, on average, the model B investor recovered their portfolio value in a little longer than half the time it took the index to recover.
For model C, on average, for the Great Depression and the Dot Com crashes, the investor recovered their investment costs in about one-seventh of the time it took the index to recover. Even more fascinating is that in ’73, ’87, and ’07, the investor never recognizes a loss on their contributions.
By the time the indexes recovered their losses across all five market crashes, the investor had averaged more than a 250% return on their contributions! The impact of the employer’s contribution cannot be understated here, where on average, the employer contributions reduced the employee’s max loss by ~75%.
Lastly, it’s important to note that while our initial models assumed a 6% employee contribution with a 100% match, these results are the same with any employee contribution as long as there is a 100% employer match.
Bottom line
It’s easy to be nervous and worrying about retirement savings is only natural during increased market volatility. When trying to do the right thing by saving for the future, it can be stressful to see the market swings impact 401k savings. But remember, the quote generally attributed to Baron Rothschild has rung true through history and will likely continue to: “Buy when there is blood in the streets, even when the blood is your own.” The benefit of a 401k is that it has no fear and continues to buy when the market is down.
People tend to overlook the last part of that quote because it implies that for long-term rewards, they will likely be faced with short-term pains. As young investors, where there is deficient wisdom from lessons learned by weathering the storm, their greatest asset is time on their side. The long-term rewards have historically outweighed short-term pain.
Tony Jacoby, CFA, is a portfolio manager at Shelton Capital Management and joined the firm in November 2017. He has a B.A. in Economics from the University of Colorado Boulder. He is currently pursuing an M.S. in Applied Mathematics with an Applied Probability concentration at the University of Colorado.
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Notes:
*Market Crashes: 1929 Great Depression, Bear Market of 1973 – 74, Black Monday of 1987, 2000 Dot Com Bubble, 2007 – 09 Great Recession
**For example, if in model B you invested $100 and the portfolio value doubled to $200, we note the portfolio performance as 100%, while in model C, the same $100 investment would be matched by $100 and then if the portfolio value doubled to $400, we would note the portfolio return as 300%, as we are basing the portfolio performance on the employee’s contribution.
This article was originally posted in 401(k) Specialist Magazine.
