How about those US banks?

In case you’ve been living under a rock (or wisely avoiding all financial news), here’s the latest…

Several banks in the US and Europe have essentially collapsed under the pressure of rapid interest rate changes over the last 12 months or so.

This has, unsurprisingly, caused panic in the markets.

Given the memories people have of the GFC and the financial system breaking, it’s causing many to wonder if we’re going to see a repeat of this in 2023. But, so far at least, the issues seem to have been contained, with the problems far less complex than the leverage and derivatives-fueled shenanigans of the GFC.

We’ll have to wait and see what happens from here. It could get worse, or it may all blow over in another month. Either way, it’s worth asking the question: “does any of this really matter to long term investors?”

An uncomfortable question

This question is likely to cause a level of discomfort with some people. Do big events like a recession or financial institutions collapsing matter to long term investors?

“Of course they matter! How could they not?!”

Look, I hear you. In one sense, any scary event like this matters because it can affect our personal situation. Market declines, an economic downturn, and a shaky financial system can cause heavy job losses, affecting a lot of people.

So in that sense, yes, it does matter. But it’s also worth noting that when unemployment rises during a recession, the overwhelming majority of the population simply carry on in their paid employment.

To be fair, job loss and personal setbacks can happen regardless of the broader economy, so that’s not specifically unique to scary events. Plus, given how much fear and emotion tends to surround things like this, it’s helpful if we also take a broader, more general perspective too.

Do scary financial events actually stop you from reaching your goals? How much does it affect your ability to save, invest, and become financially independent? Or, to borrow a stoic phrase, do we suffer more in our minds than in reality?

Let’s look at some turbulent times from the past to see how an investor might have fared. We’ll just look at the US market to keep things simple.

Past market setbacks

During high inflation and an oil crisis during the 1970s, shares performed horribly. From January 1972 to December 1974, US shares (the S&P 500) returned approximately -35%.

A painful experience, no doubt. It was similar to the sharp fall during the COVID crash of 2020. But what impact does this have over the long term?

An investor who put in a chunk of savings (say, $10,000) at the worst time in 1972, and then added nothing extra would have still earned a return of 10.4% per annum up to March 2023, assuming dividends were reinvested (ignoring fees and taxes).

But someone who magically sidestepped the drama with perfect timing, and invested when the recovery began in 1975, would have earned an annual return of 11.6%.

That’s a decent difference, I think we can agree. But the unlucky investor has still ended up with a fantastic outcome. I hardly think they’d be depressed at the long term result.

All they had to do was keep holding and reinvest their dividends. And if they kept adding to their investments along the way, the gap would close even further. Adding just $500 per month would boost their return to 10.8% per annum.

Alright, how about the painful ‘lost decade’ after the tech crash in 2000?

From September 2000 to January of 2003, US shares returned around -37%.

An investor who invested at the worst time in September of 2000, and held to today, would’ve earned a return of 6.4% per annum. Not bad considering the ‘lost decade’, but not overly exciting either.

Our lucky market timer, on the other hand, waited until January 2003 to begin. This investment has shown a return of 9.6% per annum up to now. That’s quite impressive. Hooray for market-timing!

But wait. What if our unlucky investor kept adding money to their portfolio each month?

Well, if they managed to add $1,000 to their portfolio per month, their 6.4% annual return became 9.3% per annum. That’s a huge improvement!

And just quickly, what about the GFC? Well, jumping in before the crash - say April 2007 - and simply holding through to today, would’ve still yielded a surprisingly good return of around 8.5% per annum.

Adding regularly improves that to over 10% per annum. Now, we could continue on with the examples, but you get the idea!

What does all this tell us?

Well, in the fullness of time, investors are rewarded for staying the course despite the uncomfortable setbacks along the way. Even more so if they continue to invest while the market is down.

These downturns, which are undoubtedly scary at the time, eventually pass. And those who invest through it all can look back many years later and be proud of the result.

Now, obviously there are no guarantees of the future. But if we can stomach the short term uncertainty, sticking with our plan during scary events is likely to improve the outcome rather than make it worse.

Some of you will have invested through the covid crash in 2020. Others simply remember it being a very uncertain time. Those who stuck with their plan and continued buying through the crash, ended up buying shares during the scariest and most uncertain period in modern history.

As such, a number of purchases were made at much lower prices than we have today, despite the recent falls. Can you see how investing through the scariest times can often be the most profitable?

Of course, we only know that looking back - it’s still scary at the time!

Why do I think this principle will remain true? Because regardless of short term events, the long term future and trajectory of the share market is unlikely to change very much. Technology will keep progressing, humans will keep innovating, and companies will keep finding new ways to make more money.

Sure, some companies will go bankrupt, but other firms will grow and thrive. And a bunch of the biggest future companies aren’t even in existence yet! For diversified investors (like those with index funds), this will all be reflected in their investments automatically.

So if that’s the case, then those scary events don’t really matter. Because ultimately, what drives the majority of our financial progress is how much money we’re saving and investing in the first place.

Practical takeaways

You might think the lesson is here to aim for perfect market timing to maximise your returns. Plenty of people aim to do just that (mostly with low levels of success, I’d say). So that’s probably not a realistic goal.

As we can see, regularly adding to the portfolio during a downturn had a solid improvement on overall returns. Plus, the act of adding money itself guarantees that the portfolio is bigger than it otherwise would be. The truth is, our portfolios will never grow all that much if we’re too scared to keep adding to our investments.

Next, when living through scary events, it’s easy to fall into a negative mindset. We begin to think the next speed bump will be more like a mountain. That convinces us to change our plans, or hit pause on our investments, to see how it plays out.

Unfortunately, we can’t know when markets will stop falling and start rising again. Just like when they’re rising, we can’t know when they’ll stop rising and start falling. So what do we do?

We focus on what we can control. Our personal financial habits. Sticking with our long term plan. Whether we invest or not. How much we invest. And how much attention and mental space we give to short term issues.

Don’t let your actions and your goals be dictated by market prices. Have the achievement of your goals be dictated overwhelmingly by your own actions.

That’s how you feel more in charge of your finances and your destiny. And funnily enough, when you focus on things within your control, it has non-financial benefits. Research has shown that people who feel in control in their lives are more satisfied and less stressed than those who don’t.

Now, you’ll often hear things like “the market is still down 20% from its peak” or “prices have gone nowhere for years.” But in reality, when you add to your investments over time, these data points are completely irrelevant.

Because, again, instead of one purchase at the worst possible time, you’re continually buying at lower prices, plus earning income all the way through. This has the handy effect of improving returns and boosting the outcome versus a specific date price comparison.

Final thoughts

Before we finish, I want to reiterate that I’m not saying scary financial events are wonderful.

If you’re personally affected in terms of job loss, that’s another matter. But for long term investors, it’s worth putting short term events - even unsettling ones - into a broader perspective.

Looking at any long term sharemarket chart tells you that the market eventually recovers. And the biggest regret is more likely to be NOT investing, rather than continuing to invest.

Lower prices now translate to better future returns. That’s the silver lining. So when prices fall, I’m always looking to top up my portfolio. And the more it falls, the more I want to buy.

Sticking with our investment plan and personal goals during scary periods has two major benefits:

• Our portfolio and investment income is larger than it would be if we sit on our hands, waiting in fear.
• With repeated action, we make it much easier to keep the momentum going. As soon as we pause, it’s much harder (mentally, at least) to get going again.

Until next time, happy investing!

Dave