FREE NEWSLETTER
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.
Want to receive our weekly newsletter? Sign up now. How about our daily alert about the site's latest posts? Join the list.
Excellence article. Thank you for sharing your insights!
Phil, really a useful and insightful article- this will help us all stay steady and calm during the waves of the markets! Well done, sir!
Some suggestions:
1) use a bucket approach with 1-2 years cash, 8-9 years in bonds. That way you lose nothing if the market recovers in 1-2 years, and reduce losses relative to stocks for up to 10 years (although the recent swoon in bonds did hurt, but that was the worst bond loss in history. when
will it repeat, no one knows)
2) rebalance to your stock/bond allocation when 5% off
3) if you have cash available to invest consider buying a total market index fund on a correction, definitely when the market reaches bear territory, the market will recover at some point
I think this is the best article I’ve ever read on Humble Dollar.
Would you consider taking cash dividends in 2024 part of your withdrawal strategy, ie.4%? I’ve taken cash dividends to help rebalance my portfolio. As my earned income has dropped, I’ve begun to use interest and dividends to fund our lifestyle. Still holding off on SS until 70.
Harold, I’m at the age where I must take Required Minimum Distributions from my traditional IRA. So, in my case, I use RMDs as my withdrawal strategy. Personally, I have never followed the 4% Rule so I couldn’t comment on it. If you’re interested, RMDs as a withdrawal strategy is discussed by retirement researcher Steve Vernon in his book “Don’t Go Broke in Retirement.”
Up until age 75, I always reinvested dividends in my Vanguard Total Stock Market index fund (VTSAX). I decided to redirect those dividends to my money market account starting this year to provide extra income to deal with inflation and higher prices for groceries, health care and other non-discretionary expenses.
I only harvest dividends from a broad market index fund. Given the diversification provided by such a fund, the annual dividend payouts are reasonably consistent. I agree with Jackie below that dividends are not risk-free. Still, those dividends are a potential source of additional income. In retirement, it is comforting to know that they are available should the need arise.
Personally, I wouldn’t swap VTSAX for a dividend-focused fund like Vanguard’s Dividend Appreciation Index fund (VDADX) because of the reduced diversification. VDADX fishes in a smaller pond than VTSAX.
Interesting. Just curious. Why forego years of SS between FRA and 70 and use dividends and interest which could be reinvested and then provide a higher income stream later? Or take SS and invest it until needed.
I believe the most prudent course is to utilize your IRA/401K funds to essentially buy into an increased inflation protected “annuity” that is Social Security, delaying claiming until 70. This will also decrease your RMDs in the future.
I know you took Social Security at around your full retirement age and then invested the money in munis, and it seems that — because you did that yourself — you feel you should encourage others to do the same thing. But are you sure your advice is good, given how valuable Social Security is as inflation protection and longevity insurance, as well as a benefit for the surviving spouse? Or is there a risk you’re leading folks astray, especially those with no guaranteed lifetime income?
SS is practically risk free inflation adjusted income. Even though dividends may outperform SS, they are not risk free. Some retirees need risk mitigation more than wealth maximization.
If you think it is better to take SS and invest it until needed then why wait until FRA instead of 62 to take SS?
I built a spreadsheet and proved that the math worked for me and my wife with our facts and assumptions.
“In fact, along with Social Security and other income, it has the potential to reduce my withdrawal rate to zero.”
Why stop at zero? If you have enough income from investments, you can continue to save money and buy more stock in retirement. Run out of money? No way!
Excellent information. Regardless of the trials and tribulations we have gone thru as a nation over the last 50 years, companies like Coke,Kimberly Clark,Johnson and Johnson,Black and Decker have continued to pay and raise their dividend every year for over the past 50 years. Yes, boring can be beautiful
True, but other well known companies that paid dividends for many years no longer exist.
As an example, Hostess Cakes. I worked for them for thirty four years. Seven months after I retired they went bankrupt. Then they sold out to a hedge fund company and their pension plan became insolvent
Well, It isn’t an illusion. When security prices go down your wealth is reduced. In 1979, when the Fed increased the discount rate, and the accounting profession decided that S&Ls had to mark (value) their assets at market instead of book value, hundreds of these institutions were instantly insolvent.
On March 9th, of 2009 I looked at my net worth and, as a result of the Great Recession, it was down by over one million dollars from the last market high. I was less wealthy!
One of the challenges in discussing financial topics is its nomenclature. There are many ways to define income depending on whether you are discussing taxes, overall finances, economics, etc. Okay, so it is true that as a cash basis taxpayer, when security prices go down you haven’t realized a loss unless you sell. The reduction in your wealth is still real.
Use of terms like “loss of money” is deceptive. It depends on what definition of money you are using. If people don’t understand that their wealth has been reduced, they might make other bad decisions. So, as a general rule, just my opinion of course, I think we are better off dealing with reality rather than pretense. Risks are real. Declines in security valuations are real. Investors must have courage to invest.
Yes, on March 9, 2009 you were less wealthy. Still, I would argue that if you didn’t sell any shares at a loss, you didn’t permanently lose money in spite of the severity of the downturn. In fact, I suspect that your net worth has increased substantially since then, especially if you continued to invest when prices were down.
My portfolio was also severely impacted by the Great Recession, but I didn’t suffer a permanent reduction in wealth as a result. In fact, over time, my net worth increased and ultimately was greater than its value at the peak before the recession hit.
The point of my posting was that it is the loss of money that is an illusion, not a decline in wealth. In fact, our level of wealth is always bouncing around as markets gyrate. I agree that a decline in wealth is real, but since bear markets always recover, that decline should be temporary. At some point, an increase in wealth is real too.
If circumstances are such that you are forced to sell shares to raise cash when the market is down then, yes, the loss of money is real. There is no illusion.
One final note. When the Fed increased the discount rate in 1979 and S&L’s were forced to mark their assets to market, the capital base of some S&Ls fell low enough that the government was forced to declare those institutions insolvent. Individual investors aren’t responsible for the health of the banking system and don’t face this problem.
“…but since bear markets always recover, that decline should be temporary.”
Tell that to the Japanese investor who has seen 30+ years and still no return to the 1989 highs. Temporary can be a very long time, longer than one’s ability to weather it, especially if in retirement. Most people are going to feel(and in reality be) less wealthy in a market downturn regardless of any hopes for a future recovery arriving in a timeframe that meets their own personal needs.
According to Ned Davis Research, the average length of a bear market in US stocks since 1929 is 9.6 months. The longest bear market in US stocks lasted 31 months between 2000 and 2002.
In modern times, the US has never seen anything close to what the Japanese experienced since 1989. The US economy is also much larger and more diversified than the Japanese economy.
I don’t believe that one should be excessively fearful of a bear market in US stocks based on what the Japanese experienced. The Japanese underperformance since 1989 is a more potent argument against home bias and for international diversification.
Seem to recall reading somewhere something to the effect that past performance is no guarantee of future results. I’ve always considered that a prudent point of view and will continue to invest accordingly. Believing that stocks are guaranteed to always return from a downturn in time to satisfy one’s particular needs is wishful thinking, an illusion if you will. We’ll just have to agree to disagree on that point.
I agree. While history shows you are likely to regain your wealth if you leave it in the market, unexpected emergencies could force you to sell some of your market assets.
Curious if you were heavily weighted in financial or bank stocks? That was a rough time, 2008-2009.
I think my allocation at that time in LC was about 2/3 VTV but virtually all asset classes were down, including bonds until the Fed starting Quantitative Easing.
Is the reduction in your wealth real or also temporary?
Wealth, like health is always transitory. The value of everything is always changing, including the currency we use in stating a value. A Statement of Net Worth, is a snapshot of an instant in time. While, income and cash flow measure changes over time.
There ought to be some sort of phobia named specifically for the fear some have of losing money. They will pay interest on a loan to buy a car that they know will lose value without giving it a second thought, but let their 401k suffer a temporary setback and all hell breaks loose.
Chrometophobia is the fear of losing money. It’s a real term and a real thing
Your assessment of the feelings is of course correct. I believe it has to do with one’s sense of agency over a situation.
In the car example, “I” have decided to throw away the money (interest) on the value losing car. In the case of the 401k, the market has ripped it out from my hands.
Kind of like how people drive crazy when they are behind the wheel of a car, and yet, feel awful flying in an airplane where they have no control.
In the car, they have the illusion of being in control of everything.
Phillip, I admit to a buoyant spirit when the market is high, even though I know I may be paying above retail. But I’m also sooo thankful I was working and able the buy during the big bears of the 2000s. And compounding still amazes me. I’m a simple man. Good article, good for my thinker.
Ed, I’m also amazed by compounding and grateful it exists.
When I think back on all the dumb investment mistakes I made when I was younger, I can only shake my head in disbelief.
But compounding saved my bacon and allowed me to make up for those mistakes.
How right you are. I recall repeated stories in the press following the 2008/09 crash. “Retirement savings wiped out!” they shouted. Even today people claim to have lost their retirement – only if you were foolish and sold out of the market.
I am guilty of daily moaning about the paper losses I admit. My wife claims I only tell her about a days decline, never the gains.
About dividend yield. I get into heated arguments with people who insist THEIR yield changes with the daily price of the stock. THE yield changes, but if you bought shares at $100 and the dividend is $5.00 your yield will always be 5% unless the dividend changes. Right?
Dick, as I understand it, dividend yield is the annual amount of dividends paid divided by the current stock price. So, as the current stock price bounces around, so will the calculated dividend yield.
Yet, if a company maintains its dividend, shareholders should continue to enjoy that income stream regardless of the dividend yield.
Yes, that’s the current yield. If someone asked what the yield was, that would be the answer, but my and your actual yield is based on the price we paid because our base price won’t change.
Dick, I only look on up days unless I’m buying more equities at a reduced price. This keeps me from agonizing over a reduced portfolio value. It works for me as I have only bought more in the downturns.
Dick, I’m just the opposite. A down market makes me tight-lipped and terse, trying to tamp down my emotions. I try not to be mercurial, but money causes something deep in my gut to bubble up into my brain.