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Harmful Illusion

Philip Stein

MANY FOLKS EQUATE a stock market downturn with losing money. I often hear comments like, “I lost money yesterday. The stock market went down.”

I believe this impression of loss is an illusion, one that can be detrimental to our financial health—because it blinds us to certain fundamental truths.

1. Illusion of lost money. You only lose money if you sell shares at a loss. If you don’t sell amid a downturn, you still have the same number of shares as before. To the extent those shares pay dividends, that income stream should continue. And if you reinvest those dividends, you’ll be buying more shares at lower prices. While the value of your portfolio may be lower than it was previously, it doesn’t represent a real loss of money if you don’t sell.

2. Temptation to tinker. Behavioral economists have found that we experience the regret of a loss with twice the intensity that we feel the pleasure of a gain. If you believe you’ve lost money in a market downturn, the pain of that illusory loss could tempt you to tinker with your portfolio to either make up the loss or prevent further losses. Such actions rarely benefit investors. You’re more likely to harm yourself because such tinkering is usually an emotional reaction to events—and emotions don’t serve us well when making investment decisions.

3. Increased dividend yields. Dividend yields often rise in the wake of a market downturn. Dividend yield is the amount of the annual dividends divided by the current stock price. Simple arithmetic tells us that when the current stock price declines and dividend payments continue undiminished, dividend yields rise. A rising dividend yield hardly represents a permanent loss of money.

4. Higher expected returns. During a bull market’s euphoria, share prices at elevated levels probably mean lower expected returns. By contrast, following a market downturn, stocks are less likely to be significantly overvalued and, indeed, should provide better future returns. In fact, panic selling in a bear market can result in shares being significantly undervalued. Normally, this is a harbinger of superior future returns and not a permanent loss of money, assuming you hang on.

5. Importance of shares, not price. If you regard a market downturn as a loss of money, you may be reluctant to buy additional shares, feeling that you’re throwing good money after bad. If you wish to build an income stream in retirement, however, the number of shares you ultimately accumulate is more important than the value of your portfolio at any particular moment. A good way to gather more shares is to buy when prices are down.

When a fund declares a dividend, it pays so much per share. Obviously, the more shares you own, the more money you’ll receive—and the more money you receive, the more potential income you can enjoy in retirement. That’s a nice option to have.

I’ll use myself as an example. I began purchasing shares in the Vanguard Total Stock Market Index Fund (symbol: VTSAX) in 1998. Over the ensuing 25 years, I reinvested dividends and periodically purchased additional shares—yes, even in the down years of 2000-02 and 2007-09. In 2024, at age 75, I plan to have Vanguard redirect future dividends to my money market account to give me additional income. In 2022, the fund paid me more than $13,000 in dividends. Most of those dividends were qualified, meaning I paid taxes at the lower capital gains rate, not at income tax rates.

This boost to my income will reduce the amount I’ll have to withdraw from my portfolio for living expenses. In fact, along with Social Security and other income, it has the potential to reduce my withdrawal rate to zero.

Over the 25 years I’ve owned Vanguard Total Stock Market, I experienced several market downturns. With hindsight, I can say today that all those downturns were irrelevant, and in no case did I ultimately lose money. The current value of my investment is of secondary importance to me. Most important is the number of dividend-paying shares I own and the income they provide. By focusing on the number of shares I own, I have a better picture of my financial progress than watching the market value of my holdings wax and wane with the economy.

6. Risk and return. Periodic downturns are what make stocks a risky investment. Without that risk, returns wouldn’t be as generous as they have been historically. The belief that a downturn represents a loss of money ignores the reason we shoulder stock market risk, which is to earn better long-term returns at the expense of short-term volatility.

7. Looking ahead. Long-term investors don’t view market downturns as a loss of money. Instead, they understand the cyclical nature of markets and regard any downturn as a temporary setback that should be followed by better returns. In fact, those future returns will likely be greater than if the downturn had never happened.

If you regard a market downturn as a loss of money, try to shift your perspective and consider it an opportunity for better future returns. If you can come to regard the downturn as an opportunity, you may find you grow more risk-tolerant—and you might be willing to devote more of your portfolio to stocks.

Now retired, Philip Stein was a public health microbiologist and later a computer programmer in the aerospace industry. He maintains that he’s worked with bugs, in one form or another, his entire career. Phil and his wife Jeanne live in Las Vegas. Check out Phil’s previous articles.

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