When stocks collapsed in March, why were we surprised? Markets do that from time to time. This is the seventh crash I've covered as a journalist, not including several crashlets in between.
Emotionally, they've all affected investors the same way: Our breath shortens, our pulses race, and we kick ourselves for having been so optimistic about stocks the week before. Stress drives out rational thinking. We forget that, after crashes, it's too late to sell. That switching to CDs will lock in losses permanently. That the stock market, on average, has always — always! — recovered and gone higher.
Often following crashes, we run after new investment ideas that we imagine will keep us safe the next time around. Usually they don't, because, to be perfectly blunt, stocks are never safe; they're not supposed to be. But something has changed since the turn of the century: Investors have migrated toward stock index funds. Used properly, these funds can see investors through the current crash and future ones with greater stability and confidence. Before I talk about why, let's take a trip down memory lane.
50 Years of Downs & Ups
The S&P 500 Index — a common barometer of the U.S. stock market — fell 20 percent or more six times in the half century before 2020. Those bear markets, as they are typically known, averaged about 16 months.
I'll start with the Nifty Fifty of the 1960s and ‘70s. Those were 50 blue chip companies that supposedly could stand tall no matter how much you paid for shares in them. The market plunge of 1973-74 blew away that illusion. Stocks dropped 48 percent; most of the Nifties dropped further still. Some of them recovered, although at a slow pace. Investors’ infatuation with such once-mighty names as S. S. Kresge, Polaroid and Simplicity Pattern cooled.
In the 1980s, corporate raiders roared into town, carving up old-line companies to deliver “shareholder value” and hot takeover stocks. Chancy enterprises found financing for their corporate-makeover ambitions in the booming market for junk bonds. Math geeks dreamed up “portfolio insurance,” a computerized scheme supposedly guaranteed to keep money safe by selling at the first sign of a market drop.
Unfortunately, all the computers caught the sell sign at the same time. The result: Black Monday, October 19, 1987. Stocks fell 22.6 percent, still the largest one-day percentage drop ever. A friend on a coast-to-coast flight said his pilot announced the prices as they tanked. As usual, selling turned out to be a terrible idea.
Within a year, stocks had erased their losses and were heading to new highs. Dot-com highs, namely. As the 1990s progressed, investors clamored for initial public offerings, or IPOs, for a parade of tech companies whose prices sometimes doubled or tripled in a day.
When I talked to investors during those bubble years, no one wanted to hear about prudent asset allocation or mutual funds. Some dot-coms, notably Amazon, showed staying power. Others vanished in the 2000 tech-stock crash, which sliced the broader market in half. Pets.com, the poster child for the fad, traveled from hot IPO to bankruptcy in just nine months.
In the 2000s, investors began to lose faith in brokers, big-name mutual fund managers and individual stocks. Real estate, the new sure thing, crashed in 2006, ushering in the financial crisis. From 2007 to 2009, stocks were down by half. Weary investors quit speculating.
Money began to pour into—yes!—simple, low-cost index mutual funds and exchange-traded funds. The most popular index funds follow the broad markets as a whole. Decades of testing show that, on average, they outperform funds run by high-priced investment managers. They almost certainly beat a random collection of individual stocks. Investors discovered asset allocation, too. They put some money into stock funds and some into bonds; bond funds cushion your losses in stocks.
Rookie's Guide to Index Investing
What they are
Index funds are a low-cost, fuss-free, relatively conservative way to invest in U.S. and international markets. These funds spread your dollars across the stocks or bonds included in popular market indexes, such as the S&P 500 (a basket of roughly 500 large U.S. stocks).
How they perform
Because of their hands-off approach, index funds charge an average of 0.15 percent of your investment annually, compared with 0.67 percent for actively managed funds. This lower cost helps fuel their performance: Last year, just 29 percent of active U.S. stock-fund managers outperformed their benchmark index after fees, calculates the investment service Morningstar.
How to buy
You can invest directly with a mutual fund company, which will handle all transactions and send you statements. If you wish, you can usually manage your portfolio yourself on the company's website. Minimum investments sometimes apply. Alternatively, you can invest in exchange-traded funds, which also track indexes but can be traded throughout the day, like stocks.
What to Buy
Among the hundreds of index funds available, you're best off with those that track broad swaths of stocks and bonds, such as the total U.S. stock market. The simplest approach is to invest in an index fund that itself consists of several index funds; many target-date retirement funds are in this category. Target-date funds comprise a mix of stock and bond funds, automatically adjusted to become more conservative as the year of your expected retirement approaches.
Another simple option
Invest in three types of index funds: a U.S. total stock index fund, a total international-stock index fund and a U.S. total bond index fund. If you need to take cash from your portfolio, you would want to avoid taking it from the fund performing the worst, so that you don't lock in that fund's losses. Every major fund family — including T. Rowe Price, Schwab and Vanguard — has an array of index-fund options; Fidelity even offers four index funds with zero expenses or investment minimums.
Naturally, index funds fall when the indexes do, so the question arises: After this year’s Corona Collapse, will investors once again search for something new? I hope not. Individual stocks might fail, but the broad market never does. Past crashes have been just a blip in a rising market; by one calculation, downturns since 1950, on average, have taken a little over two years to recover, if you reinvested dividends.
Personally, I added to my stock-index funds during March. If I had been obligated to take a required minimum distribution from my IRA this year (none of us has to; the government waived RMDs for 2020), I would have drawn from my bond funds—principally Treasuries, which rose in value—while waiting for stocks to recover. If I had a 401(k), I would keep putting money into it.
It’s never the end of the world. Stock and bond index funds, plus patience, always win.
Before My First Bear Market
I found my calling in the 1960s, after I quit my low-level job at Newsweek. I was 23, and I dreamed of being a real journalist. Friends said I was nuts to leave, but I wanted to write. Back then, women at Newsweek weren't allowed to become writers.
My dad, a businessman, advised me to go to the Katharine Gibbs secretarial school. He thought I was smart enough to become the assistant to a CEO — in his opinion, a top position for a woman. I was astonished.
Luckily, a friend referred me to a publication called the “Insider's Newsletter.” It had a section for men (business, investing — serious stuff) and a section for women, which covered topics such as the emerging women's movement and the growing political interest in fairness in consumer finance. At the time, Congress was considering what became the Truth in Lending Act: ending deceptive disclosures of the interest rates lenders charged. The government was pouncing on other misleading practices, too.
The editor of the women's section offered me a job reporting and writing these stories. I said, “I don't know anything about consumer finance.” She said, “Learn."
So I did. I read books, subscribed to financial publications and found experts who patiently explained to me how financial products worked. It turned out that I loved it — especially when I pursued duplicity in the financial industry and helped consumers avoid traps. Later, I used what I'd learned to cofound the “Business Week Letter,” published by McGraw-Hill. We covered business, investing and economics. Then the Washington Post asked me to start a syndicated column on personal finance, which, happily, became a success.
Sheer luck landed me in a place where I could not only write but also develop an expertise that excited me all the time. My dad could hardly believe it. I even converted him into a supporter of job equality for women. And in 1970, after 46 female employees filed a complaint with the Equal Employment Opportunity Commission, Newsweek came around, too. —J.B.Q.