It’s not “if” – it’s “when”. Whilst of course we can’t be 100% sure of what will happen in future, the stock market has crashed many times in the past, and it’s highly likely that it will crash again in future. But you shouldn’t worry about it – here’s what happens when it crashes.
Firstly, the current value of your pension plan will reduce. This is because like almost all pension plans (we think literally “all”, we just put “almost all” to be on the safe side), the assets held within your pension plan are pieces of ownership of large companies - in our case, the 500 largest companies listed on the stock exchanges of the USA (which includes companies based in other countries). So whilst there are tens of thousands of companies listed on more than 200 stock markets worldwide, and you “only” own a piece of the top 500 companies, you can be sure that when a global crash happens, your pension value is going to be affected. When “the stock markets” go up, your pension goes up in value, when they go down, it goes down in value.
If you are a short-term investor, investing all your money at one time, and you get your timing wrong, it can be devastating – because whilst some recoveries happen quickly, some happen much more slowly, and it can take years to get back into profit. But if you’re a medium-long term investor – which you are, if you have a pension plan – stock market crashes can actually be beneficial to you, or at least not have a negative effect.
Why? Because of what’s known as “Dollar Cost Averaging” (DCA). To make a profit in any investment, you need to get back more than you put in (obviously). If you invest all at once, you have one purchase price, and to make a profit, you need the end price to be higher than your purchase price. So if you invest all in one go just before a crash, you might be stuck with a long wait before you’re back in profit.
When you’re investing regularly, such as paying into a pension plan every month, you don’t have one purchase price – you have several purchase prices. Over ten years, you would have 120 different purchase prices for example (12 per year x 10 years). Over 20 years, you’ve got 240 purchase prices. So to make that all-important profit, you don’t need the end value to be higher than the start value – you just need it to be higher than the average value that you paid for those assets.
This means that when you invest a fixed amount of money each month, you actually buy more assets when the price is low (for example just after a stock market crash), and buy fewer assets when the price is high. For example, if one “unit” of the S&P500 Index costs $1.00, and you’re investing $500 per month, you’re getting 500 “units” of the S&P500 Index. If the price goes up to $1.25, your $500 will get you 400 “units”. And if the price falls to $0.80, your $500 will get you 625 “units” that month.
Over time, you know that the values will be variable – they always are. By investing on a regular basis instead of all in one go, you flatten out all the peaks and troughs, and are investing at an average price over time, not at one fixed price at one point in time.
Because nobody knows when stock market crashes will happen – and by extension, nobody knows when the value will reach a new all-time high either – it is much safer and lower risk to invest gradually, rather than all in one go, which is why this style of investing is perfect for pension plans. The purpose of a pension plan is not to make you wealthier next week or next month, it’s to make you wealthier in several years’ time.
Financial planning experts all over the globe refer to this way of building wealth as “it’s not timing the markets, it’s time in the markets”. This means that the way to sustainably build wealth over the medium-to-long term is not to focus your energies on trying to guess when it is a good (or bad) time to invest, it’s better to start your financial planning as soon as possible, so that you can spend as much time “in the markets” as possible. Crashes happen, they probably always will happen, but in between those crashes there will be years of growth and dividends (company profits paid to shareholders), and a few anti-crashes also (where the value jumps up unexpectedly, instead of down).
Playing around with investing over short time frames can be both fun and nerve-wracking, both profitable and disastrous, and if you want to try it, it’s now easier than ever to do so. Just don’t take silly risks with your pension plan, use other money for playing around and let your pension plan money slowly but surely build up a nice large pension value over the long term.
Of course, past performance is not a guarantee of future performance, but unless you’ve somehow got an accurate way of knowing exactly what is going to happen in future, what has happened in the past is usually a good place to start looking for information. And in the past, many of those crashes which seemed like the end of the world at the time, now appear as little blips on a volatile but steadily increasing chart of stock market growth.
Big companies make big profits, year after year (with a few exceptions, occasionally) and by being a part-owner of 500 big companies, you can (and should) be extremely confident that over time, your pension value will increase a lot more than if you kept it in cash, or invested into something which is purely speculative. Owning (or part-owning) profitable businesses has consistently been the best way to generate wealth for thousands of years, and that is unlikely to change, even if the market crashes once in a while.
The absolute worst-case scenario regarding stock market crashes is if it happens just before your target retirement date – because unlike at the start or middle of your plan, at the end it doesn’t have the time left to benefit from the recovery. That’s why we’ve chosen to feature this particular pension plan product from Investors Trust – because it comes with a capital guarantee that you will not get back less than you invest, and for two of the three duration options it also guarantees you a minimum guaranteed return of either +40% or +60%. This is not something included with most pension plans, is a hugely valuable protection to have in place, and one of the key reasons why we’ve chosen this pension plan for our own retirement planning – it takes away a lot of risk, and the guaranteed minimum returns are backed by a fully audited, A- rated, licensed and regulated, multi-jurisdictional insurance company. We love it :-)
So don’t worry about the markets crashing – as Dory nearly said: Just keep saving, just keep saving…