These days, whenever the Dow Jones Industrial Average (DJINDICES:^DJI) drops by triple digits, news and financial-media outlets seem to use a formula for frightening headlines in order to spur readership. Here's an example of just a few headlines that have crossed the wires this year:
- "Gimme Shelter: Dow Tumbles 394 Points as Calm Gives Way to Chaos "
- "Dow Plunges Over 600 Points as U.K.'Earthquake' Crushes Global Markets"
- "Dow Plunges 400 Points on Fed and Nuke Fears"
The list goes on, but the recurring theme is that you should be fearful of "plunging" stock valuations.
The funny thing about "plunges"
Yet what these scary articles rarely mention is that such losses are a regular function of the stock market. Of the 20 largest single-day nominal declines in the Dow's history, 15 have occurred since September 2008.
The Dow's most recent "plunge" -- the 394-point drop that occurred on Sept. 9 and is referenced in two of the headlines above -- didn't even crack the top 20 in terms of worst all-time nominal losses. And it came nowhere near cracking the top 20 worst percentage losses of all time; that 394-point loss translated to a decline of 2.13% -- less than a third of the 20th-largest percentage decline in the Dow's history.
It's important to keep the market's moves in perspective. Though a 394-point drop might look big on paper, that's a pretty small swing, considering that the Dow has risen roughly 11,500 points from its March 2009 bottom -- good enough for a 175% gain.
See that small yellow highlight on the right? That would be the recent 2.13% "plunge" in the Dow. Of course, you'll also notice the fairly steady incline in stock prices since March 2009, which makes the 394-point decline look negligible.
Now let's look at an even bigger picture: the Dow's performance over the past 30 years.
Note the two highlighted sections. The highlight on the far right represents our most recent decline. In the context of the Dow's more than 10-fold increase since Sept. 11, 1986, it's barely noticeable. But what really stands out is just how diminutive Black Monday (the Dow's 22.6% single-day decline in 1987) appears in this long-term chart. Although Black Monday was the worst day in the Dow's history, and perhaps the truest definition of a "plunge," time has turned that earth-shaking event into a minor blip that today would amount to a less than 3% decline.
Plunges beget opportunity
Not only are stock market dips often far less dire than the media would have you believe, but they often give way to some of the markets' best days.
The natural reaction to sinking stock prices is often fear -- at least for short-term investors. Big single-day losses often foreshadow increased short-term volatility, which can be unnerving if you're invested heavily on margin, if you have most of your money tied up in only a few stocks, or if you invest primarily in speculative companies.
However, historical data shows that large stock market declines signal an opportunity for long-term investors to buy. Fifteen of the Dow's 20 largest single-day gains came within a month of its greatest losses. In other words, stock market "plunges" are a sign of opportunity, even if the headlines make you want to run for the exit.
Need more proof?
Earlier this year J.P. Morgan Asset Management released a report entitled "Staying Invested During Volatile Markets" that discussed the interaction between the S&P 500's (SNPINDEX:^GSPC) best and worst single-day performances over a 20-year period between Jan. 3, 1995 and Dec. 31, 2014.
J.P. Morgan Asset Management found that investors who had held throughout the entirety of the 20-year period -- which includes both the dot-com crash and the Great Recession -- gained an average of 9.9% per year, or 555% overall. That return trounces the rate of inflation. However, if an investor somehow missed just over 30 of the S&P 500's best days over this 20-year period, then the aforementioned 555% gain would have been entirely wiped out.
What's more, the data showed that the S&P 500's biggest gains tend to come within two weeks of the biggest single-day losses. So if you sat on the sidelines waiting for the storm to pass, then you probably missed out on quite a few of the S&P 500's best performances. That could seriously hinder your efforts to grow your nest egg.
So the next time the headlines describe the market as "plunging," pull up a 30-year chart of the Dow or S&P 500 for some perspective on just how insignificant single-day down moves can be -- and how important it is to invest for the long haul.