Yes, Your Stocks Will Drop

With the US stock market at all-time highs, you're probably wondering whether the bottom is about to fall out. If I knew the answer to that, I'd retire the day after the drop. But here's what I do know: if you invest money in the US stock market today, tomorrow, next week or next month, it's quite likely that you'll lose money, at least temporarily. Not just at all-time-highs though...this has been the case most of the time, and there's no reason it would stop being that way.

Look:

 Losing before Winning

 

I chose this fund because it's a widely-held index fund tracking the S&P 500 stock index - the most commonly-cited index for US stocks. Each vertical red slice marks a day where the future value of an investment in this mutual fund was lower by more the percentage listed. The losses might have persisted for just a single day, or they might have lasted for months or even years. On the first line, for example, the slices mark days when a $1,000 investment in the fund left you with less than $975 at some future date. Below that are lines marking days with subsequent losses greater than 5%, 10%, and 20%.

But here's the important thing: I created this chart when the stock market was at its all-time high. An investor in the fund on any day since 1980 would have made money. Nobody's lost. So by definition, all of those 2.5%, 5%, 10% and 20% losses were only temporary. All you had to do was sit tight, and do nothing, and you eventually made money.

This chart would look different depending on when you ran it, but this is as good as it gets (again: all-time highs). And it's pretty harsh! At the moment, 76% of investing days since 1980 had subsequent losses greater than 2.5%, 61% had later losses greater than 5%, and nearly half of time time, future losses were over 10%. I didn't bother including it, but if you look at losses of any level, even tiny ones, the figure is even higher: that happened over 93% of the time. "Loss of principal" isn't just possible, it appears to be extremely likely.

All of these figures include dividends paid by the fund, assumed to be reinvested, and are mutual fund (not index) returns so factor in the fund's expenses. They're good indicators of what a buy and hold investor in the fund might actually have seen, before taxes. And of course, they apply not just to an investment made on the charted day, but to the value of an account measured on that day. It shouldn't be too upsetting that an account value is lower than it was on a prior account statement; that happens most of the time!

Though a large number of days have a red slice marking an over-20% bear market drop, those days haven't been randomly distributed. They're in a few discrete clumps. Each clump was tied to a major economic event, and preceded by all-time highs for the stock market: the crash of 1987, the bursting of the dot-com bubble, and the debt failures and recession after the housing bubble. Two bubbles, and a trading-driven market blow-up.

The next 20% drop - and there will be one - seems likely to be tied to a big event as well. In a way, that's a truism, because a market drop is itself considered a big economic event even if there's really no good explanation for it (the '87 crash is an example). But there's nothing special about all-time highs as a trigger. As can be seen above, many highs haven't been followed by a bear market. An investor avoiding stocks during the highs of much the 1980's and 1990's would have missed out on years of subsequent gains, and never had a chance to buy in at the older, lower levels. Running the chart back to the 1920s shows the same thing. Simply put, it takes more than an all-time high to indicate that stocks are about to plummet.

Notes to nitpickers: technically the fund was worth 0.03% less than the prior day as of 6/30/2014, so the all-time high was the 27th. And if I sized the graphic big enough you'd see a few stray white slices buried in the red areas, that are probably below the resolution of your computer screen.