Why down markets are 'ideal' for young investors

I’m still thinking about a financial tweet I saw on New Year’s Eve.

It shows a screengrab from a TikTok picturing a young, smiling woman, whose username is cropped out. The superimposed text reads, “When the market falls at the same time you decide to invest, so you’re buying shares cheaper and can earn higher returns.”

It’s unclear to me whether the account that tweeted this was mocking her or not. Plenty of people in the replies were.

Others were defending her. And with good reason. While there is no shortage of laughable investing advice to be found on social media, this struck me as good, sensible stuff, especially given what the market has done of late.

The S&P 500 index is down more than 18% over the past 12 months, and many individual investments, such as prominent tech stocks and cryptocurrencies, have faired far worse. It’s enough to cause many investors to panic, when most market experts will tell you to do the exact opposite.

“A down market is actually an ideal situation for a relatively new and young investor who has signed up for a dollar-cost averaging approach in a retirement account such as a 401(k),” says Sam Stovall, chief investment strategist at investment research firm CFRA.

Dollar-cost averaging is a classic long-term investing strategy that involves investing a set amount of money into your portfolio at regular intervals. There’s no guarantee that the woman from TikTok is doing it or plans to. But if she is, here’s why she’s right to be excited that the market is down.

Market history is on your side in a down market

Describing the shares she hopes to buy as “cheaper” means that the TikToker is assuming stock prices will bounce back. In the short term, there is no telling whether they will or not. But over long periods, the broad stock market has reliably trended upward.

“The market is up in 73% of calendar years since World War II,” says Stovall. “You have to think that if the market is down one year, it’s likely to be up in the next.”

Historically, investors haven’t had to wait long to recover from the sort of down market we find ourselves in now. The broad market is currently down 20.5% from its January 2021 high, putting it in the territory of what Stovall calls a “garden-variety” bear market — characterized by a decline of 20% to 40%.

In the 10 times that’s happened since 1945, the market has bounced back to breakeven in 27 months, on average, according to CFRA.

“Understanding the speed with which the market recovers from deep selloffs can allow investors to use stock market history as virtual Valium,” says Stovall. “Knowing you’ll get back to breakeven can calm your nerves.”

Dollar-cost averaging lowers investors’ price tag over time

Importantly, all of the above data applies to the broad stock market, not individual stocks, which can plummet to zero and never come back. But assuming you have a broadly diversified portfolio, buying near the market’s bottom means you’ll earn higher returns when it eventually finds its way to new highs.

That isn’t to say that this market has necessarily found its bottom. In the short term, it could bounce back up from here or continue to fall. That’s where dollar-cost averaging can come in handy by taking market timing out of the equation.

By consistently putting the same amount of money into a broadly diversified portfolio, you’ll guarantee that over time you’ll buy more shares when they’re cheaper and fewer when they’re expensive.

And the sooner you start investing consistently, the better. That’s because younger investors have time on their side: the longer you’re in the market, the more time your portfolio has to grow at a compounding rate.

Say our TikToker invests $1,000 today and $100 a month thereafter. If she retires in 45 years, assuming an 8% annualized return on her investments, her portfolio would be worth nearly $570,000, according to CNBC Make It’s compound interest calculator.

Were she to make the same contributions and earn the same return, but wait five years to get started, her portfolio value would fall to just over $375,000.