Market downturns can be good for your portfolio. Yes, really!

In the News

For many people, the way the market has been performing since the beginning of the year is an indicator of an impending correction. Although it’s historically true that market corrections have usually come on the heels of long periods of sustained expansion, pinpointing the exact moment when a drop will occur is more a matter of chance than anything else. You may well be right, but far too soon.

That being said, when you are building up your savings, did you know that market downturns can actually help you grow your assets? That seems counterintuitive, doesn’t it, so let’s look at an example to illustrate our point.

Take two investors, Paul and Catherine. Both will invest the same amount over the next three years. However, Paul will be investing $300,000 this year, whereas Catherine will invest $100,000 in each of the next three years.

 

Investor

Investment - Year 1

Investment - Year 2

Investment - Year 3

Paul

$300,000

$0

$0

Catherine

$100,000

$100,000

$100,000

 

Now let’s look at three distinct market scenarios, selected for illustration purposes:

 

Scenario

Return - Year 1

Return - Year 2

Return - Year 3

Annual compound return

1 – Significant market downturn in Year 1

-15%

16,7%

16,7%

5%

2 – Significant market downturn in Year 2

5%

-15%

29,7%

5%

3 – Steadily rising market

5%

5%

5%

5%

 

Finally, let’s calculate the value of our investors’ portfolios at the end of the third year:

 

Investor

Scenario 1

Scenario 2

Scenario 3

Paul

$347,287

$347,287

$347,287

Catherine

$368,655

$355,718

$331,013

 

Indeed, by investing all his funds as of the first year, the value of Paul’s portfolio will remain the same, regardless of the scenario. He will gain an advantage over Catherine only in scenario 3, where the market rises three years in a row. As for Catherine, she’ll be richer according to scenarios 1 and 2, having invested less than Paul during the two corrections, but she would still benefit from the rally by continuing to invest each year. Surprising, isn’t it?

So, even if you believe the stock market will fluctuate over the next few years, remember that when investing, slow, but especially steady, wins the race.

The Claret Team