Should You Invest More After the Market Declines? – Of Dollars And Data

One of the most common questions I have received from readers is:

it would be better to invest plus money after a market crash?

For example, if you were originally investing $500 per month, should you double it to $1,000 per month once the market is down 20%, 30%, etc?

Logically, this seems to make sense. After all, most market declines are short-lived, so buying after a decline is the same as buying at a temporary discount, right? What could not be loved?

Unfortunately, the data only seems to agree in the extremes. For example, since 1926, future returns only seem to increase during the largest declines (40% or more). We can see this by examining the one-, three-, and five-year annualized future returns on the S&P 500 broken down by drawdown level (i.e., percentage of all temporary highs):

As you can see, the median one, three, and five year annualized returns when the market is down >20% or >30% is almost identical to the returns during all months. This suggests that there is no additional benefit to investing more during drawdowns of this magnitude.

However, once the market is down 40% (or more) from all the all-time highs, everything changes. At this point, it seems that the benefit of doubling up is quite large. In particular, after a drop of more than 40%, the S&P 500 tends to return 25% during the next year compared to 13% (in all months) and 12.8% annually for the next five years compared to 11.1% (in all months). This suggests that there is a huge benefit to “buying the dip” during the biggest of dips.

But, maybe we should use a time period that is more comparable to modern times. Although I usually rely on data going back to the 1920s, some have argued that this data is not that useful because of how much the US stock market has changed since then. I see your point. So I did the same analysis as above, except this time I started with the data in 1988 (I’ll explain why I chose 1988 in a bit).

Starting in 1988, we can see that there is now a benefit to investing in the S&P 500 after a 30% (or more) decline, in addition to the benefit of investing after a 40% (or more) decline:

In fact, after a 30% drop since 1988, the S&P 500 is back 20% during the next year compared to 14% (in all months) and 12.4% annually for the next five years compared to 11.7% (in all months). This suggests there could be some short/medium term benefits to investing more after 30+% drops, but who knows? After all, a limited time period of a single stock market doesn’t feel like enough information to determine if we should invest more after a market crash.

Therefore, I have also performed the same analysis on the All Country World Index ex US (“ACWI ex US”) beginning in 1988, when the ACWI ex US data begins. And, based on the data below, it appears that the benefit of investing after a drop in international stocks is even greater than the benefit found in the US:

As you can see, at all drawdown thresholds tested, future returns for the next one, three, and five years are higher than for all other months. If anything, this means that buying the dip in international equities worked better than buying the dip in the US since the late 1980s.

Given the information above, investing more after a market crash (especially a big crash) seems like a no-brainer. I do not disagree with the data. However, there is a major problem that this strategy does not address.

The problem of investing “more” after the market crash

So far we have shown that future returns tend to be higher after a larger market decline. This implies that we must invest plus money when the markets are in crisis. But as logical as this strategy may seem, it contains a fatal flaw: it creates money out of thin air. Let me explain.

Let’s go back to the example at the beginning of this article and assume you’re investing $500 a month in the S&P 500. Let’s also assume that if the market drops 40%, you’ll double your contributions and invest $1,000 a month in the future. My question is: where do you get that extra $500 a month?

Do you evoke it with a spell? Do you print it at home? do you pick it up from friends and family?

Jokes aside, this is the main problem with this “invest more during dips” strategy. You have to have money on the sidelines waiting to be invested to be successful. However, as I have illustrated before (see here, hereand chap. 14 of just keep shopping), this will lead to less money most of the time

You might reply that you don’t have to have “cash on the margin” because you could simply reduce your expenses or increase your income once the market has gone down. Yes it’s correct. However, you would answer that if you could reduce your expenses or increase your income sometime in the futurethen you could do the same right now instead.

After all, why not make those changes now and start investing that extra money today? Statistically, you’d be better off about 80% of the time and you wouldn’t have to wait for a future drop either. Of course, this doesn’t feel as good as investing during a “generational buying opportunity” or telling your friends you “bought the dip,” but you can’t have it all.

Regardless of what you decide to do, raising your contributions after a sharp market downturn is likely to be more rewarding than buying during normal times. However, don’t forget that if you can find extra money during a decline, you can probably find that extra money now, too.

Happy investing and thanks for reading!

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This is post 312. Any code you have related to this post can be found here with the same numbering: https://github.com/nmaggiulli/of-dollars-and-data


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