Millennials Should Love it When Stocks Dive
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On Thursday, the Dow dropped more than 330 points.
This is almost always covered as bad news. And for a lot of people, it is. Say you've just retired. If it turns out there's a bear market in stocks over the next few years, you could have a serious problem.
But if you're in your 20s or early 30s, you should "pray for a long, awful [bear] market," says financial adviser William Bernstein, author of If You Can, a short ebook about investing for Millennials.
Because the math of a market drop moves in your favor. As long as you are making regular contributions to stock fund in a 401(k) or IRA, you are a buyer, not a seller, of equities. A market drop means you pay less for more shares.
And since you haven't had time to invest much yet, your losses on the stocks you already own are only a small part of your lifetime wealth. If a market drop was in the cards, better to get it out of the way early.
Now, it's not quite as simple as "the market drops, high returns follow." Sometimes stocks fall, fall some more, and stay down for a long time; the American experience (so far) of the market inevitably recovering old highs isn't some natural law, as an investor in Japan would tell you. If the long term prospects of the American economy over your lifetime are deteriorating, and it turns out a market drop accurately reflected that, then a crash is not especially great news.
But a lot of the ups and downs in the market are really about changes in investors' appetite for stocks, and how much they're willing to pay for a dollar of company profits. Right now, according a measure popularized by Yale economist Robert Shiller, investors are paying 25 times earnings for U.S. stocks, considerably more than the long run average of 16. (But also way less than the record of 44 hit before the great dotcom crash.) Logically, if you pay more for earnings now, you should expect a lower return in the future. Just flip the Shiller PE over (divide the earnings by the price) and you see that stocks are priced to deliver an "earnings yield" of 4% per year, vs. a historic rate of over 6%. (For more on the math, Morningstar's Sam Lee has a good explainer here.) Want that extra 2% back? All else being equal, stocks would have to fall 36%.
Millennials might not wish that fate on their headed-to-retirement parents. But it would boost the return they could expect on their own savings.