The sky is falling!
The market is about to crash!
The youth of today are corrupted!
Every innocuous thing you love is Bad, Actually!
Doomsaying is the grift that keeps on giving. Spread fear and doubt about some looming crisis—real or imagined—and you instantly take on a mantle of wisdom and moral authority.
Best of all, you don’t need to have any special knowledge or insight. No-one will call you on your bullshit. You can be wrong over and over and over again, and everyone will still gather around, spellbound, to listen to your wise counsel.1
Humans are wired up to take a potential threat much more seriously than an equivalent opportunity. We can’t help but prick our ears up at this kind of thing. Or as we say in the news business: if it bleeds, it leads.
And so, we end up with headlines like this:
2013: THE NEXT STOCK MARKET CRASH: Why Many Pros Think It Has Already Begun — Business Insider
2014: Has the Stock Market Crash of 2014 Begun? — The Motley Fool
2015: The Stock Market Crash Of 2015 Is Just Getting Started — ETF Daily News
2016: Stock-market crash of 2016: The countdown begins — MarketWatch
2017: Is The Stock Market A Bubble Waiting To Burst? — NPR
2018: We are now in a bear market — here’s what that means — CNBC
2019: Don’t Be Fooled By The Latest Stock Market Rally — Forbes
These are not trashy clickbait merchants. They’re some of the most prestigious titles in the financial press. I’m pretty sure I’ve written articles of this nature before. There’s nothing malicious about it—everyone is following their incentives, and this is what the public wants. I like reading these kind of stories as much as anyone. Too bad they’re not worth the paper they’re printed on.
The headlines look especially silly when you overlay them on a graph showing what actually happened to the stock market over the last 10 years:
Of course, the prophets of doom will get their satisfaction one day*.* They’re constantly calling for a market crash, which means they’ll eventually be proven right, entirely by accident. On that fateful day, they’ll level a trembling finger at the charts, and pronounce the most satisfying words in the English language: I told you so!
(no-one will remember that they’ve been saying this literally every single year, and that taking their advice at any other point in time would have been a really bad idea.)
When we zoom out to look at the past 90 years of stock market history, we can see several cycles of booms and busts. And so, it’s not a question of if there will be another crash, so much as when.
We’re currently experiencing the longest bull market in history, with 10 years of sweet, sweet gains:
If you look at the graph, it kind of looks like we’re due for a downturn. Note the vertical grey bars, which mark a recession in the economy. Hmm. Haven’t had one of those in a while.
Except this is not how markets work! There is no cosmic overseer who eyeballs the charts and introduces a crash when we’re ‘due’. There’s just seven billion people trading and saving for the future and inventing new things and declaring wars and learning and having children and dying and passing laws and exchanging information and creating companies and generally going about the project of human existence.
The market is a collective intelligence that emerges, bottom-up, from this stupendously complex web of constant interactions. To claim to be able to predict it is a claim of omniscience.
Maybe there will be a stock market crash today. Maybe it will be next month. Maybe it won’t happen for another 10 years. I don’t have a clue, and neither does anyone else.
I say all of this as a prelude to the fact that I, too, am kind of worried about what happens when the market crashes. I’m not trying to spread fear and doubt to make myself look wise. I’m a dum-dum. But at least I know I’m a dum-dum.
So, there are no predictions in this post. They’d inevitably be wrong, and if they were right, it would only be by coincidence. Instead, I want to explain why my views have changed in recent years.
I never used to worry about the market crashing, because the conventional advice is that it doesn’t matter. I’m still not losing any sleep over it. But I do want to push back just a little on that advice, and add a bit more nuance to my previous writings on this topic.
Hold the Line
The standard line is that for long-term investors, market crashes just don’t matter a damn. You pay no attention to the headlines, and calmly ride out the volatility. After all, you’re buying productive businesses: their prices at any given point in time are of no consequence when you’re holding onto them for 20, 30, 40, or 50 years.
The real money is made when you not only hold the line, but keep buying during the downturn. That way, you get to pick up stocks in a discount sale that only comes around once every decade or two.
Here’s the section on timing from the Beginner’s Guide to Investing:
I have repeated the standard line many times. It is, as far as I know, technically the best advice. But lately I’m getting more of an appreciation for the difference between technical models—tested under sterile laboratory conditions—and what actually works out in the messy real world.
When the market crashes, it falls for more than a year on average, and loses over 30 per cent of its value. And that’s the average. Sometimes, it’s a lot worse. When crashes happen, we know for a fact that many otherwise smart people panic and sell out, with the worst possible timing.
If you wake up one morning and see tens of thousands of dollars missing from your precious retirement fund, all rational thought tends to fly out the window. You have to know yourself: when the crash comes, can you brave a 30 per cent decline without flinching? What if it happens in the space of a couple of days? How will you sleep at night? Do you have an ulcer? No? Do you want one?
I think it’s a good idea to visualise these kinds of scenarios in as much detail as you can, and really try to ‘feel’ it. Be honest with yourself about how you might respond in a crisis. Maybe it makes sense to take some money off the table, or have a portfolio that isn’t 100 per cent in stocks, even if it’s technically not the best strategy.
Crying ‘Uncle!’
Even if you know you have the intestinal fortitude to hold the line through the bad times, the universe has a way of messing with your best-laid plans.
Traders talk about their ‘uncle points’. When someone is twisting your arm out of its socket, there will come a point you’re in so much pain that you have no choice but to cry ‘Uncle!’ and close out the position, no matter how much it humiliates you, or ruins all your plans.
Maybe you don’t plan to cash out your investments any time soon. But life comes at you fast. What if you lose your job, or your marriage, or your house burns down, or a loved one gets sick? If you can provide solid answers to these kinds of questions, which ought to involve words like “insurance” and “emergency funds”, that’s great. But you can’t eliminate every uncertainty.
The new orthodoxy of the financial independence and early retirement (FIRE) movement is built around the belief that buying-and-holding index funds is a guaranteed way to get rich:
- Thou shalt not try to pick stocks.
- Thou shalt not time the market.
- Thou shalt not trade in and out.
- Thou shalt set up an automated drip-feed, and hold the faith through good times and bad.
- Once thou hast saved ~25x your annual expenses, thou shalt retire early.
I still think this is very good advice. But FIRE hasn’t really been tested under fire yet.2 It assumes we’re capable of behaving like Mr Spock during a crisis, even when all our instincts are screaming at us to panic. And it doesn’t account for uncle points.
There’s one more assumption that deserves some closer scrutiny, so this post is gonna have to be a two-parter. Next up: just how safe are index funds, really?
Notes:
Footnotes
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e.g. professional doomsayer and New York Times columnist Paul Krugman (sample quote: “By 2005 or so, it will become clear that the Internet’s impact on the economy has been no greater than the fax machine”), or Paul Ehrlich, who was showered with awards and honours for likening humans to cancer and being persistently wrong about everything, and the long line of fellow Malthusians promoting the kind of policies that make Thanos look sane. ↩
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The FIRE movement began in the 90s, but it really only started becoming a cultural force in the 2010s, through the writings of Jacob Fisker (Early Retirement Extreme) and Pete Adeney (Mr Money Mustache). Coincidentally, the property market and the share market have been on a hot streak ever since. ↩
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