It’s always unsettling to watch the value of your savings slide. However, while today’s circumstances may be new, market crashes have long been part and parcel of investing. As such, history can teach us a thing or two about how markets can recover from periods of instability – and may provide a little reassurance.
Human emotions and their impact on markets
The trouble with financial markets is that they’ve been created by humans. As such, they’re vulnerable to a range of human emotions: fear and greed are the top two, but there are others – the instinct to follow a herd, for example. This means that there will be times when they show excessive optimism and others when they show excessive pessimism. This just fuels the fire of bubbles and crashes.
However, it’s important to look through these ups and downs to the longer-term returns they’ve given. The long-term growth rate from a mixed portfolio of company shares (also known as equities) is around 4%*. Most importantly, that’s a ‘real’ return – in other words the return after inflation, although past performance isn’t a reliable guide to future performance.
Holding cash over the past 10 years would have lost you money because savings rates have generally not been enough to beat inflation, reducing the purchasing power of your money over time. The occasional market crash is the price you pay for the higher returns available from investing. You don’t get the highs without the lows.
What history has shown us
At the time of writing, the FTSE® 100 Index** is down by about 30% from its highs earlier in the year. This is a painful but middle-ranking crash in a historical context. It beats the ‘Black Monday’ of 1987, but doesn’t yet beat some of the falls seen in response to the global financial crisis or the unwinding of the technology bubble.
19 October 1987 – ‘Black Monday’ saw the largest one-day fall in the Dow Jones Industrial Average Index in 30 years, with the index dropping 508 points – 22.6% of its value. Plenty of investors panicked and sold out, but those who were patient were rewarded.
10 March 2000 – The technology-heavy Nasdaq Index peaked at 5,048, only to fall to an all-time low of 1,108 by October 2002. The period preceding the slump had every characteristic of a full-blown market bubble. That said, at the time of writing the Nasdaq Index sits at 7,373 and the share prices of some of the companies caught up in the bubble, such as Amazon, have gone on to increase substantially.
15 September 2008 – Investors will still remember the savage sell-off in markets that followed Lehman Brothers filing for Chapter 11 bankruptcy protection. The bank collapsed under the weight of its debts, triggering a financial crisis that threatened the entire banking system. Like most global stock markets, the FTSE® 100 Index sunk heavily, though many of these losses were caused by the banks, which saw savage falls. Those who bought at the peak of the crisis had to wait several years for the FTSE® 100 Index to recoup its losses, but they would have seen gains since then.
6 May 2010 – This was the US stock market ‘Flash Crash’. The Dow Jones Industrial Average Index suffered its worst intra-day point loss, dropping nearly 1,000 points, before recovering almost all of its losses moments later. The crash – thought to have been caused by algorithmic trading (automated computer programmes) – lasted just 36 minutes.
When looking at all these examples, remember that past performance isn’t a reliable guide to future performance. And, although history has shown that markets do generally ‘bounce back’, there are exceptions. Japan, for example, saw an asset bubble in the late 1980s and its markets have never again seen the valuations they achieved during those years. There are also specific sectors that have been through periods of high valuations never to recover – such as UK banks.
The key is not to put all your eggs in one basket
Instead it can be a good idea to spread, or diversify, your money across different types of investments and geographic regions. That’s because different investments tend to behave in different ways – what causes one to fall can cause another to rise. So if this happens, you’re less likely to see the overall value of your investments change dramatically.
And finally, try not to panic. Although the circumstances in each case have been different, from an investor’s perspective, we have been here before…
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*Source: Barclays 2018 Equity-Gilt study
** FTSE International Limited (‘FTSE’) © FTSE 2020. ‘FTSE®‘ is a trade mark of the London Stock Exchange Group companies and is used by FTSE International Limited under licence.
The information in this article should not be regarded as financial advice. Please remember that the value of investments can go down as well as up and may be worth less than was paid in. Information is based on Boring Money’s understanding in April 2020.