340 comments

What to Do About This Scary Stock Market

shockmonsterRecently I’ve been getting a lot more emails that go something like this:

Dear Mr. Money Mustache,

I’m a new reader and I’m interested in improving my money situation. Spending less, earning more and investing. But when I checked out your article on stock investing with Betterment, it looks like a terrible deal. You’ve pumped in $116,000 to that account over the last 16 months and yet the current value is only about 110 grand. You’ve lost almost six thousand dollars!

I think you picked a lemon – I think I’ll either find a financial adviser that can make me more money, or stick with my savings account. Half a percent is a lot better than losing six grand!

While these emails are always a little bit unfortunate (because it means I haven’t done a great job making my investing articles easy to find), I’m actually thankful for the drop in my account value. And the even larger number of dollars I’ve lost in the rest of my retirement savings sitting at Vanguard and other places. It’s not just six thousand dollars that has disappeared from my net worth in the last sixteen months – it’s hundreds of thousands. And yet I feel better about investing than I did at the very peak of the stock market’s lofty heights back in summer 2015. How could this be?

Welcome to Real Investing!

Stock market performance since I started this blog.

Figure 1: Stock market performance (including dividends) since I started this blog. Results from our IndexView tool.

The reason to celebrate is that is a completely normal and healthy part of investing. Stocks have been on an almost uninterrupted climb since I started this blog in 2011, which may have given beginners an unrealistically rosy picture. But now we’re seeing a more natural pattern, and I’m glad. Because this actually means more wealth for all of us. It’s a sale on stocks.

Buying Stuff at Lower Prices is Better

Think of it this way: Suppose you’re just starting out as an egg farmer, and your goal is to build up a nice, profitable business. You want to build up a flock of hens so big that they are eventually producing thousands of eggs per month. Enough to live off for life and retire.

You buy your first 100 hens, and they get right to work. You allow those eggs to hatch so more hens can be born, and you also continue to buy hens from the farm supply store. Suddenly your phone rings and it’s Farmer Joe down the road. “The price of hens has just dropped by 50%! You’ve just lost five grand on those hundred hens you bought last summer!”

Is this a sensible way to think about it?

No, of course not. You’re happy that hens are cheaper, because now you can build your egg business even faster.

Stocks are just like hens. They lay eggs called “dividends”, which are real money that can either flow automatically into your checking account, or automatically reinvest itself to buy still more stocks. Some younger companies don’t pay dividends, but that doesn’t mean they aren’t making you money – they are just reinvesting their profits to grow even faster – and eventually become a Super Hen.

There’s only one time you care if one of your shares is down: on the day you sell it. And as a wise lifetime buyer of only low-fee index funds, this day is sometime well into your retirement, only after you’ve spent your dividend income and drained down any other cash reserves you might have sitting around.

How to See a Dividend in Real Life

If you type the name of any stock or exchange-traded fund into a market analysis website like Google Finance, you’ll see a field called “Yield”. That’s the annual dividend payment you get for owning those shares, as a percentage of your investment. Let’s try it out:

For Vanguard’s  “Everything in the US” fund called VTI, you get this:
https://www.google.com/finance?q=VTI

This fund is showing a total annual dividend of 2.04% at the time I type this.

Interestingly enough, when I wrote the basic text of this article a month ago, stocks were 10% lower and that yield was thus 10% higher (2.24%) since the dividend rate hasn’t changed even as the price swung around.

Similarly, if you look up the Vanguard “Everything Except the US” ETF with ticker symbol “VXUS”, you get this:
https://www.google.com/finance?q=VXUS
And its current dividend yield is 2.94% – much higher because European/World stocks are currently cheaper than US ones.

If you own shares in either of these funds, actual Dividend Eggs show up in your account every 3 months. You can use them to buy more shares, or to buy edible eggs or other groceries.

Selling Stuff over a Long Period of Time means Smooth Sailing

So you’re a Mustachian and spend your long 10-15 year career living richly on some of your salary, and accumulating loads of index funds with the other 60% of those earnings. Once your investments reach $1 million, you decide to retire, because the 4% rule indicates that should cover your family’s $40,000 annual spending forever.

Given current stock market conditions, a ‘stash like that would provide $25,000 per year in dividends alone. So you need to sell a few shares each year ($15k worth) to make up the difference.

$15k is only 1.5% of your million dollars.

Suppose that during the your first year of retirement, the market goes up by 7%, which is roughly what it does each year if you average it out over long time periods:

Now you have $1.07M, so even after the $15k withdrawal (now only 1.4% of your account!) you’re still up over fifty grand.

Suppose the market goes down by 13%, which is roughly what happened from the highest peak to the lowest point of this supposedly bad year. Despite this fluctuation in the sticker price, you still had the same number of shares (hens), and they continued to lay about $25,000 in annual dividends.

Now you have $918,000 so your $15k withdrawal on the down year puts you down to $903k.  It sounds painful, but your fifteen thousand was still only 1.6% of your balance.

And then the stock market resumes its upward march, which it always does. Some years it goes up 20%, other years it drops by 10%, but overall the continuous stream of dividends (eggs) and growth in company value and productivity (hen size) keep you well fed and happy – forever.

So What Have We Learned?

If you’re still earning money and investing it, these are good times. The more the stock market drops, the happier you should be. Just keep your primary life stable (reasonable spending, no consumer debt, good healthy habits), and pour the rest into those investments (max out the 401(k) first, then IRAs, then put the rest into normal taxable accounts).

How to Invest in Stocks:

You can get great results by knowing only one thing: “Buy a low-fee Index Fund that allows you to own a slice of at least the Entire US Market.”

There are many funds that accomplish this, but my default choice is Vanguard’s VTI. You can buy it by getting a Vanguard account, or from any brokerage account (I have my own VTI shares in a brokerage account with my bank, just because it allows easier transfers to and from the family checking account).

More recently, I switched to dumping extra money into my Betterment account (see ongoing results here). It’s the same idea: you end up buying Vanguard index funds but with a better interface, more sophisticated worldwide allocation and tax loss harvesting that makes it worth several times their 0.15% annual service fee to me. But some pretty thoughtful readers have disagreed with my choice – be sure to read the comments below that article to get their perspective.

This article is obviously just a repetition of the oldest of investing knowledge. But it’s still a lesson that very few people understand today. Please hit your friends, your financial adviser, or the commentators on your television over the head with it if they ever express fear over a falling stock market in the future.

Further Reading:

How Much is Too Much in your 401(k)? explains why you should still put money in tax-deferred accounts even if you’re planning to retire early, because you can get it out early if needed.

The Stock Series by my pal Jim Collins goes through the philosophy of index fund investing at a leisurely pace with plenty of interesting stories and folksy wisdom.

 

  • Travis March 14, 2016, 3:05 pm

    Only problem with a scary stock market is when you don’t have lots of money laying around to invest in it. Darn wish I still had an income this year to do something about it.

    Reply
  • Mr. FrugalEnginerds March 18, 2016, 7:21 am

    A few weeks ago, my co-workers complained about the stock market and how much money they have lost in their 401K. I thought to myself this must be a great time to buy. Aside from dipping into our emergency fund, I threw all the money I could at the market. Once in the awhile the market gives us an opportunity to buy on the cheap. It’s unfortunate that some people see danger instead of opportunity and sell everything. Fear is a strong emotion…

    Reply
    • Greg January 10, 2017, 7:55 pm

      Like shooting fish in a barrel at times, isn’t it!?

      Reply
  • Chris B March 18, 2016, 12:13 pm

    I hate dividends. I’m pretty sure MMM is using them here as a proxy for return-on-equity or cash-flow-to-investors simply because it’s much easier to talk about, but consider these reasons not to buy dividend stocks:

    1) Many “dividend aristocrats” are borrowing to pay dividends – paying interest on loans to give investors a couple percent of their investment back. Would you run a household this way? Take out a credit card cash advance to pay the kids an allowance?

    2) Dividends force me to pay taxes. Reinvestment in marketing, R&D, or operational efficiency does not – and are actually deductable investments. Dividends paid from income are taxed at both the corporate and investor levels – double taxation!

    3) If I need income, I should either own safer bonds, or blow $4 a quarter in commisions to sell exactly as many shares as my spending requires. $4 is much cheaper than double taxation.

    4) Management is saying “we are totally out of ideas for how to earn a decent return on our cash. Our products suck, so increased marketing won’t increase sales. We think we are already as efficient as possible. Our whole business model is so obsolete and due for disruption that any money spent on R&D would be like making a better typewriter.” Any one of these blasphemous statements should be a fireable offense. But dividend payers are saying exactly that.

    5) Share buybacks don’t trigger immediate double taxation. The resulting share price appreciation can be deferred indefinitely by the company’s investors, who can determine when to harvest those gains. Boom. Simple solution.

    Thus, the decision to pay a dividend is always an error by management. There’s always a better way to deliver shareholder value. I’ve watched lots of high-dividend companies cancel their dividends and be left as a debt-loaded shell of their former selves.

    Look at the fossil fuel companies maintaining their dividend at all cost, while taking on odious debt. I just loaned a money hemmoraging oil company a few grand at over 10% yield FOR ONE YEAR so they could maintain a 2% dividend. Tell me they aren’t destroying shareholder value!

    Reply
    • Marc January 11, 2017, 12:31 am

      Wow. Insightful comment.

      I have never considered it that way. I think paying a dividend is so much of a norm now a days that even companies with better things to do with their money will pay a dividend to keep shareholders happy.

      Reply
  • Jeremiah Robinson March 24, 2016, 9:57 am

    Somebody should mention Robert Gordon here. He’s the first major, widely-respected economist to predict the end of growth in the relatively near future. Here’s his Ted talk. https://www.youtube.com/watch?v=PYHd7rpOTe8. He has an economics tome he just released on the topic called The Rise and Fall of American Growth:
    The U.S. Standard of Living since the Civil War. Worth thinking about, at lest.

    Reply
  • Jeremiah March 24, 2016, 10:13 am

    In this one he specifically mentions early retirement as a problem, and part of the cause of the Greek financial meltdown: https://www.youtube.com/watch?v=ofWK5WglgiI. As someone pursuing early retirement, this is something that interests and concerns me.

    Reply
  • Jeremiah March 24, 2016, 10:14 am

    Somebody should mention Robert Gordon here. He’s the first major, widely-respected economist to predict the end of growth in the relatively near future. Here’s his Ted talk. https://www.youtube.com/watch?v=PYHd7rpOTe8. He has an economics tome he just released on the topic called The Rise and Fall of American Growth: The U.S. Standard of Living since the Civil War. Worth thinking about, at lest.

    …Posted this in a new comment as the other is awaiting Moderation.

    Reply
  • Norman April 11, 2016, 8:31 pm

    What if the market drops by 40% and then you still need to take out your money? Or what if the market drops by 40% the year before you retire? What will you do?

    Taking money out of the account after the crash depletes the value even more like adding salt to the wound, doesn’t it?

    Reply
  • Allen April 17, 2016, 12:51 pm

    Is it true that VTI and VXUS have a better yield (dividend) percentage than VTSAX and VFIAX? If so, would it be easiest to leave my existing VTSAX and VFIAX alone in their taxable accounts and start purchasing VTI and VXUS from now on?

    Reply
  • Doug May 12, 2016, 2:13 pm

    Further to my above comment dated March 12 at 7:56 AM, the governor I described is working very well. Late last year and earlier this year stocks were on sale. As the speed dropped, the centrifugal flyweights dropped, which pulled on the linkage to open up the throttle so the engine could get more fuel/air mixture. The result was I bought some stocks and ETFs while they were on sale. More recently, the stock markets have gone up. The increase in speed caused the centrifugal flyweights to extend out, which in turn pushed on the linkage to close the throttle so the engine gets less fuel/air mixture. The result? I’ve sold off some of those bargains I scooped up earlier this year and late last year for some tidy capital gains. Wow, it’s really that simple. I don’t know why more investors don’t do it, even an idiot like me who failed a college financial course can understand it.

    Reply
  • Jason June 17, 2016, 5:48 pm

    Great article and analogy to the hen and eggs. I like that. To the person that says you can never tell when the markets are overpriced, I disagree. Investing, and trading is about price, and probability. If you look at historical PE ratios you will see currently we have a high priced market compared to all years on record. Many of the large players have moved out of equities. The probability of sustained returns from these prices, without a major sell off is very low. So yes you know when to not buy or buy less, and when to get in and buy a lot. You just have to do your homework.

    Reply
    • Mr. Money Mustache June 19, 2016, 8:20 am

      I agree with you Jason – stocks are less exciting as the price rises. But predicting a drop outright and then successfully selling, then re-buying shares is not something anyone (including these “large players”) can do with statistical reliability. Some succeed and claim genuius, some fail, and you can’t predict in advance which ones will be the winners until after it happens.

      The more likely outcome is that stocks will zigzag sideways for a few years while continuing to pay 2-3% dividends, until earnings catch up with prices.

      Also, the P/E (and P/E10) are high now, but not insanely high: http://www.mrmoneymustache.com/2014/08/25/indexview/

      Reply
  • Stacking Dollars July 22, 2016, 7:22 am

    The greatest fault of mankind is that we tend to think of today and ignore tomorrow.

    If people can get into the habit of thinking “this dollar is worth $10 tomorrow” we would all be better off. Sure they’ll be some ups and downs, scandals, crashes, recessions, wars, etc., but it always seems to pan out over the long run. As long us US citizens keep wanting to make money for themselves and their families, it always will.

    Index funds all the way!

    Reply
    • Greg January 10, 2017, 8:02 pm

      Um, no. The greatest fault of mankind is blindly following orders from a perceived authority figure. In finances or any other area of life you care to name.

      Reply
  • Frugalitymatters August 27, 2016, 11:10 pm

    Do you feel young investors (I’m 23) should be purchasing safer bonds for the time being since the market right now is a gigantic bubble? A lot is happening right now that we haven’t seen before. The baby boomers are flooding the market with their money making inflating stock prices way beyond their annual earnings and dividends are remaining the same so we are buying more and essentially getting less or equal in dividend returns. This could be the new normal or it could pop and then we would be in a great position to sell our bond indexes to buy more stock indexes. On top of that many countries have moved into a new commodity exchange that was created by China Russia and several other countries in which the commodities are traded using that countries currency, where as up until recently all commodities were traded using the U.S. dollar. If more and more countries stop using the traditional commodity exchange the U.S. could potentially lose a lot of power in multiple areas including our military. I can’t find anyone willing to give advice on this very new situation.

    Reply
    • Mr. Money Mustache August 28, 2016, 12:30 pm

      Great question, Frugality!

      See, what you’re doing with that comment is trying to outsmart the market using stuff gleaned from absorbing the news headlines. The market is indeed more expensive now than average, but far from ridiculous. It could still go any direction from here. It would be statistically unlikely to beat it with bonds.

      However, investing in rental properties in a cheap market with with a high rent relative to price would probably give you a much better chance. Or you could just start the stock investing and celebrate if the stocks go on sale later.

      Reply
    • SS August 29, 2016, 8:26 am

      Frugality – keep in mind that bonds will get crushed (as a general rule) in a rising interest rate environment. If you hold bonds that pay a 4% coupon for example, and new bonds are getting issued that pay 5%, the price of the 4% bond will come down accordingly.

      The “rising interest rate environment”, however, seemingly never comes to pass.

      Warren Buffett’s traditional advice might be best. Average in every quarter. If there’s a correction, you won’t have all your cash deployed and can take advantage of better prices. I don’t believe WB holds a lot of bonds – at least ones that aren’t convertible into stock at favorable terms.

      Reply
    • Eric August 30, 2016, 10:31 am

      Time in the market is more important than timing the market. If you start investing in stocks at age 23, you will be in good shape over time.

      Reply
  • Lloyd Chrismas December 19, 2016, 7:40 am

    Justin Colletti wrote:
    March 2, 2016, 1:53 pm
    “Does this mean you’re OK with buying stocks when they are very expensive and unlikely to have a good yield over a 10-30 year period?
    It just doesn’t sound very Mustachian to me to buy US stocks when they are overpriced.
    US stocks can be a great long-term value. But how great of a long-term value they are depends greatly on their purchase price.
    It seems wasteful to me to blindly throw resources at already overvalued assets. The CAPE ratio and how it plays into forward expectations for inflation-adjusted returns should play into any conversation about the long-term value of stock indexes, shouldn’t it?”

    On March 2, 2016 the Dow was at 16899.32 and the S&P at 1988.45. If he had invested in some index funds back then, instead of arguing about CAPE ratios and the market being overpriced, he would have had some good returns by now. (December 19, 2016)

    Lesson learned kids: keep investing despite market fluctuations. If prices drop, buy more. Don’t listen to people who tell you the market is overpriced.

    Reply
    • Mr. Money Mustache December 20, 2016, 4:59 pm

      Yeah, I agree with your sentiment, Llloyd!

      The only thing I’d point out is that we’re only talking about a 9 month period, so the stocks could have gone either way by 20% and it would still be a relatively meaningless fluctuation. If we happened to be at a down point right now, Justin could have followed up with a “told-ya-so” post to prove his own point.

      The real point is to come back at least 10 years from now, and compare the compounded total of all dividends plus the difference in share price to that 2016 price, and determine how we fared.

      My prediction is that it would be a lower than average return (almost guaranteed if you start at a higher-than-average P/E ratio like we have today), but still a good one.

      Reply
      • Greg January 10, 2017, 8:15 pm

        Justin *could* have come back with a “told-ya-so” post, but he can’t. Which is the entire point of this post, isn’t it? Regularly depositing into low-cost index funds works whether stock markets go up or down. Which they will always do.

        Justin’s posts attempted to predict the unpredictable and as a result he’s lost all credibility. The rest of us, meanwhile, get ever closer to our financial goals simply by chilling out on our bikes and hiking through the mountains.

        Reply

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