FOOL ON THE HILL

Party Like It's 1929

Even during the Great Depression, when it took 25 years for the Dow Jones Industrial Average to return to its Sept. 3, 1929 peak, investors who put money into the market regularly had positive returns after only five years. Only those who sat on what they had, scared off by the drop, experienced a 25-year drought. Keep that in mind today.

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By Tom Jacobs (TMF Tom9)
August 1, 2002

How many times recently have you heard something like this:

"Remember, it took until 1954 -- a quarter century -- for the stock market, represented by the Dow Jones Industrial Average (DJIA), to return to its highs before the crash of '29." Or in reference to the back-to-back declines in 1973-1974, "It was six-and-a-half years before we saw those levels again."

Wow, sure sounds bad. The natural response is to press your hands to your cheeks, � la McCaulay Culkin or Edvard Munch's The Scream, and squeal, "Oh no! A nuclear investing winter! We'll never retire! Our family is doomed!" But think again. Yes, the statements are true. It did take years for market averages to return to their previous highs. But the data supports a faulty proposition: That you better provision the family bomb shelter, because you won't see bull market highs for a long, long time.

Whether it makes sense or not, this thinking scares people away from stocks. I'm not denying the pain of the current bear market that started in the beginning of 2000. It's especially unfortunate for people within a few years of retirement who lacked appropriate asset allocation. But those with a number of years until retirement need to realize that time is on their side. The truth is that the persistent and consistent investor can make money in as little as five years after a market crash of 1929's magnitude. Here's why.

How most of us invest
Most of us didn't put our every dime into stocks at the market top -- when the Naz lapped 5,000 and the S&P 500 embraced 1,500. And even those who did probably still earn money to invest either through 401(k) plans or after meeting expenses at the end of the month. The danger? That we become too freaked out to invest what new income we have.

Most people don't invest just once with a lump sum. They invest in their company-sponsored 401(k) plan through paycheck deductions, directing their tax-advantaged contributions to (we hope) the low-expense S&P 500 or other broad market index funds every employer should offer. Simply, most of us dollar cost average our stock purchases this way. Through periodic investing like this, we buy more shares when prices are lower, fewer shares when prices are higher, not guessing or being taken hostage by the market tops and bottoms. If we're lucky enough to have more investable funds, we can invest those periodically, too. 

If you are this kind of regular, dollar cost averaging (DCA) investor, you shouldn't care less when the Naz will hit 5,000, the S&P 500 will see 1,500, or the DJIA will scrape 12,000 again, if ever. The worst thing that can happen to your financial health is not a severe bear market or market crash, but letting those events scare you away for years from periodic investing in stocks. Here's some proof.

What if we DCA'd through the Depression?
Many of us started investing in individual stocks when the Internet made company information and the investing process much cheaper and more widely accessible. The 1990s turned out to be a period of unrestrained stock market enthusiasm similar to the 1920s. Let's put ourselves back 80 years and see how two different investing styles would work. 

First, we'll imagine investing a lump sum in all DJIA stocks at the market's high, represented by the DJIA's Sept. 3, 1929 peak of 386. Second, we'll posit investing the same amount of money that day and continuing annually on Dec. 31 from 1930 until the DJIA returned to 386 again in November 1954. (I chose these dates because they're related to the data I could find on the Web.)

Here are the compound annual growth rates (CAGRs) after each five-year period until the DJIA hit 386 again in November 1954:

               COMPOUND ANNUAL GROWTH RATES
                     Lump sum       DCA*  
5 years  (1929-34)    -23.1%       +0.1%
10 years (1929-39)     -9.0%       +4.4%
15 years (1929-44)     -6.0%       +2.8%
20 years (1929-49)     -3.2%       +3.9%
25 years (1929-54)      0.0%       +7.0%
*Dollar cost averaging

Amazing, huh? The Great Depression was the worst sustained economic catastrophe this country has seen. Unemployment hit 24.9% in 1933. Year-over-year GNP declined from 1930 to 1933, turning up again only in 1934. Yet regular investing still yielded a positive annual compound growth rate after only five years -- and that's even without adding in the Dow stocks' dividends. That seems like a long time today but not when compared the 0% return rate for investors who added no money for 25 years. Then five years begin to look darn good.

Small CAGRs add up
If you think these single-digit CAGRs don't make a difference, think again. (Remember that 72 divided by your annual rate of return gives you the number of years it takes to double your money.) We put some real dollars with these figures:

                 DJIA     $1000   Investing  
         DJIA    Change  Lump Sum  $1000/
          On     From     9/3/29    Year
         Date    9/3/29  Balance  Balance    CAGR
09/03/29  386     --     $1000    $ 1000           
12/31/34  100    -73%    $ 270    $ 5015    +0.1%
12/31/39  155    -61%    $ 390    $12778    +4.4%
12/31/44  136    -61%    $ 390    $18899    +2.8%
12/31/49  177    -48%    $ 520    $30545    +3.9%
11/54     386      0%    $1000    $66612    +7.0%

You may not think that a gain of $41,612 on an investment of $25,000 is that great for 25 years, but it sure beats the alternative -- 0% return (or worse, if you sold out along the way!). 

This exercise ignores some important items. I treat inflation as a wash, though there was actually some deflation during the Depression, and I don't include the significant dividends paid then by the Dow stocks. And $1,000 a year is a ridiculously large sum to use for an average person back then, but slice or add zeroes to suit yourself. Also, in any bad times, you are generally fine if you have a job: In the Depression, with money coming in, you could at least feed, clothe, and shelter yourself and those for whom you were responsible.

You were in bad shape if you, like many, were out of a job when unemployment percentages hit four times today's. But even if you had a job and investable funds, you faced higher commissions, lack of information, and no broad-market, low-expense mutual funds. Today, we are lucky: With lower commissions, broad-market index funds and exchange-traded funds (ETFs) and widespread information, we can DCA our investments more easily and reduce the damage of any bear market.

The more things change...
This analysis shouts, blares, screams -- nay, even yodels: Pay down your debt, establish a rainy day fund, live below your means, and save and invest. Keep your risky investments to low or no percentage of your portfolio, depending on your investing experience, comfort levels, and personal financial situation. Choose broad-market, low-expense index funds if you don't have the time or temperament for individual stocks. Please reread that last sentence.

This is not news to readers who practice dollar cost averaging in dividend reinvestment (Drip) or direct stock purchase plans. Those who want to join in are welcome in the plush easy chairs of our Drip discussion boards: Drip companies and Drip basics. And please take a moment to share your situation in this poll:

A. I invested a lump sum at or near the bull market tops and haven't put any more in.
B. I've been primarily a DCA investor since before the recent market tops. 
C. I started investing after the bear market began, with a lump sum.
D. I started investing after the bear market began, and I invest regularly.

The bottom line: If you continue to save and invest, and you aren't too close to retirement, don't fear that the recent bear market means the end to compound growth in your future. As most of our parents advised, get an education, keep your skills updated, and be valuable to employers.

Most importantly, nurture relationships -- those will sustain you.

Have a most Foolish week!

[Note to readers: After publication, we were informed that according to Ibbotson Associates it actually took only until the early 1940s for the equivalent of the S&P 500 -- dividends reinvested -- total return -- to pre-crash levels, but not until Sept. 1954 without dividends. This implies that the Dow Jones Industrial Average returned earlier as well if you include reinvested dividends too. More proof:  keep investing, be patient.] 

Tom Jacobs heard so much about the Great Depression from his parents, who lived through it, that he feels like he lived through it, too! He owns some stocks, which he discloses.