Given the sharp decline in financial markets since the beginning of the year, many investors might be wondering if we've seen the "top" in equity markets given that several markets including the likes of Europe (Stoxx 600, -22.2%), Japan (Nikkei 225, -23.2%), China (HSML100, -41.2%) and even our local Singapore equity market (FTSE STI, -28.45%) are down by over -20% from their peaks in 2015 (in local currency terms as of 21 January 2016), leading to many a media headline of bears having picnics and coming out to play in various markets. Given that a -20% decline is no trivial matter, investors might be seeking ways to reduce overall drawdowns and potentially recover their losses quickly given what has been one of the worst starts to a new year in financial market history.
Fortunately, a strategy exists that allows investors to reduce drawdowns whilst recovering losses quicker on their investments! While we have preached on the merits of staying the course and the benefits of a regular savings plan given that markets have tended to recover and make new highs over the long run, including our previous article in 2011 (How Did Dollar Cost Averaging (DCA) Fare Over The Past 100 Years?) that revealed a RSP has performed better over longer term frames, with positive investment returns in every instance over investment periods of 25 and 30 years, we have not shown investors specific case studies of how a regular savings plan (RSP) actually fares in various real life examples.
In this article and perhaps at an apt time, we examine market history to showcase how utilising a RSP in markets which are not bullish have helped investors weather through tough times whilst staying true to their course and longer term investment objectives.
What If The Market Goes Underwater For Two Decades?
If one was extremely unfortunate back in 1929 and managed to begin investing in the stock market at the end of August when the market was at its highest, how would they have performed? Assuming the investor froze in their boots and did not take any further action given the bloodbath in the markets as the S&P 500 tanked close to -86% from August 1929 to June 1932, then, the investor would have had to wait over two and a half decades (that's 25 years!!) for the S&P 500 to reclaim and surpass its August 1929 high and send their investment back to only breakeven!
Figure 1: Don't Stop If You've Invested At The Top!
On the other hand, an investor who had used a RSP that consisted of $100 a month and diligently stuck to it would not only have taken a much shorter time to recover their losses (just 13 months from its maximum drawdown in May 1932 to regain positive territory), but they would also have had a much lower maximum drawdown of –66.8% (as compared to the S&P 500's -86%) on their portfolio as they were continuing to add more assets at cheaper prices whilst others panicked, allowing them to average down their cost basis and allowing them to build a larger base at lower prices.
In the second largest drawdown during the period of 1929 – 1954, the S&P 500 suffered a maximum drawdown of -57.6% between February 1937 to April 1942 as a result of World War II, with the index only surpassing its February 1937 level in January 1946 for investors to breakeven, a 107 month wait (effectively a 9 year wait!) for investors who were unlucky enough to get caught at the top and did not adopt a RSP through the tough times! The application of a RSP strategy would have resulted in less pain and a shorter amount of time spent in agony, with investors suffering a maximum drawdown on their investment of -35.8% in March 1938 (the benchmark recorded a drawdown of -52.9% for the period). Through acquiring more assets at cheaper prices, investors would've had a lower drawdown of -31.1% in April 1942 as compared to the benchmark's -57.6% figure.
Figure 2: Unless The World Ends, Markets Tend To Recover!
On top of enjoying a lower drawdown, the RSP strategy would also have seen investors back-in-the-black sooner than those who were too scared to buy into falling markets, with the RSP strategy taking 20 months from when the strategy was initiated to become profitable, 7 months to recover from its deepest loss in March 1938, and 10 months from the benchmark's lowest point in April 1942.
A far cry from one who just adopted a buy and hold strategy who would have waited 107 months for the index to return to the level he entered the market.
What About More Recent Times?
Bringing things to more recent times, assuming one had bought into the market at the height of the tech bubble, one would have had to wait until May 2007 to be able to break even based on a single lump sum transaction while the utilisation of a RSP would have seen one's investment turn positive in December 2003, a difference of close to 4 years!
In summary, Table 1 below highlights some of the data displayed above as well as other periods where by Mr Market was not well.
Table 1 - Historical Analysis Of Major Market Drawdowns
| Period | Maximum Drawdown | Months to Recovery/Breakeven From Initiation |
Months to Recovery/Breakeven From Max Drawdown |
|||||
|---|---|---|---|---|---|---|---|---|
| S&P 500 | RSP | S&P 500 | RSP | S&P 500 | RSP | |||
August 1929 - June 1932 (Great Depression) |
-86.0% | -66.8% | 301 | 13 | 268 | 14 | ||
February 1937 - April 1942 (World War II) |
-57.6% | -35.8% | 107 | 20 | 95 | 7 | ||
December 1972 - September 1974 (Bretton Woods, Oil Crisis) |
-46.2% | -33.8% | 91 | 29 | 71 | 9 | ||
August 2000 - August 2002 (Tech Bubble) |
-46.3% | -28.8% | 81 | 40 | 57 | 16 | ||
October 2007 - February 2009 (Great Fiinancial Crisis) |
-52.6% | -36.4% | 65 | 25 | 50 | 10 | ||
| Source: Bloomberg, iFAST Compilations | ||||||||
Does This Mean We Should Not Invest Lump Sums?
While we have showcased the merits of RSP, investors who have a larger sum for investment should put their money to work sooner rather than later as lump sum investing has historically delivered higher returns as seen in How Did Dollar Cost Averaging (DCA) Fare Over The Past 100 Years?
With the case studies above using real historical data that includes periods of severe market distress as well as asset bubbles such as the Great Depression, World War II, Tech bubble and Great Financial Crisis, the merits of adopting a RSP strategy to ride out tough times that might look like the end of the world is on the table (Table 1) and is plain to see for all.
While a regular savings plan won't protect you from suffering losses, the deployment of such a strategy has historically proven to be beneficial to investors both in terms of lower drawdowns as well as shorter recovery periods through catastrophic crises. The adoption of a consistent approach to investing, particularly for investors caught at the top, allows one to ride out tough situations while staying invested to give the strategy the time it needs to work its magic.
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