How low can we go? That was the question on everyone’s mind as the Dow blew through the 7,000 mark in early March and made its way down to almost 6,500. As fear started to set in we caught ourselves wondering where the bottom would be. How low could we go? Was zero a real possibility?
To answer this question we first need to understand what would have to happen for the stock market to actually go to zero. All stocks would have to become worthless, which means all publicly traded companies would have to fail – all of them. With all the uncertainty and disbelief in the stock market today some investors are starting to think that’s a real possibility! But that’s not necessarily rational and a comparison to the Great Depression should explain why.
During the Great Depression unemployment reached 24.9% at its peak in 1933. A quarter of the workforce was out of work, but more importantly 75.1% of workers still had jobs. In order for the majority of workers to have jobs companies had to stay in business and earn income to pay salaries, which they did. Compare this to today. At the end of February 2009, the national unemployment rate was 8.1%, which was the highest it’s been in the past 25 years. But the current unemployment rate would have to triple to reach the level it was during the Great Depression. And remember, even if we reach that level, businesses will still survive and a majority of workers will still have jobs if the Great Depression has taught us anything. The scary part is, of course, not knowing which companies will fail or whose job will be lost next. The stock market reacts very poorly to this uncertainty, which leads to even more bad economic news and the cycle continues.
What this means for you
If you’re an investor wondering where the bottom will be, you can stop wondering. The truth is, the Dow may go to 6,000, 5,000, 4,000, or even lower, but if you believe business will survive, then you also believe the stock market will eventually regain its lost ground. Because we don’t know which companies will fail and which will survive, it’s important to have a broadly diversified portfolio made up of different stocks, bonds and mutual funds.
Time becomes a critical factor, and you need to evaluate whether you have enough time to wait for the rebound to occur. If you have less than five years until you need your money, you will probably run out of time and won’t see a full recovery. But if you’re a young investor with over ten years left before you plan to retire, you should recoup most (or all) of your lost gains.
You can speed up your portfolio’s recovery time by dollar cost averaging into the stock market each month, regardless of how the market is currently performing. Dollar cost averaging means purchasing the same dollar amount of a stock each month, regardless of its share price. This means you’ll buy more shares when stock price is low and less shares when the price is high. Dollar cost averaging is a great way to avoid market timing and take the guess-work out of investing.