A Bear Market Can Be Good for the Young

After more than two years of stock market losses, and now mounting allegations of corporate fraud, young investors probably think putting money into equities is about as Quixotic as throwing it in a wishing well--a cute, hopeful gesture, but not something to build a retirement plan on.

If history is any guide, however, sustained downdrafts in the stock market can be tremendous opportunities for those who invest wisely and for the long haul--meaning, decades.

The caveat is that investing wisely doesn’t mean buying hot stocks or shares in just a few companies that you’re sure are going to beat the market.

Wise investing, by and large, is unexciting investing. It involves regularly putting money into a diversified portfolio of stocks representing a broad spectrum of U.S. companies. And it means holding those shares--and even buying more--during dismal periods when your returns are likely to be negative.

“You should really hope for a bear market when you are young. It gives you a chance to buy stocks at lower prices,” said Steve Norwitz, a spokesman for mutual fund giant T. Rowe Price in Baltimore.

Naturally, people who are close to retirement have a different view of bear markets. Stocks can--and very well may--languish for years. When you’re near retirement, you may not have the time to wait out extended slumps before tapping your nest egg.

“For the person who is retired or almost retired, this market is a disaster,” Norwitz said. “But for the person who is 20 or 30 years away from retirement, a bear market is a great way to accumulate assets.”

You might expect to hear that from someone representing a mutual fund company. But that approach also is championed by the likes of billionaire Warren Buffett, one of the most successful investors of all time.

Long-term optimism about stocks is rooted in one basic belief: Over time the economy will grow, and so too will many companies.

Big-company stocks--as measured by the Standard & Poor’s 500 index--have returned an average of 10.7% a year since 1926, even though 10.7% has never been the actual return for any single year.

Over one-year periods, stock returns are all over the map. Big-company stocks lose money in about one in every four years. In other years they make up for lost time, earning substantially more than the historical average.

Still, there are some noteworthy patterns. Among them: Periods of above-average returns frequently give way to periods of below-average returns and vice versa.

In the late 1990s, Wall Street generated far-above-average returns. Now there’s talk about a long period of poor returns. Young investors may hope that talk rings true.

Let’s take a look at how a new investor would have fared had he gotten started in the early 1970s--just before the worst bear market since the Great Depression.

Let’s assume that this hypothetical young investor started socking $10,000 a year into big-company stocks at the end of 1972 and continued to do so at the end of each year through 1992.

In five of those years, this investor’s portfolio suffered losses. But the worst losses were at the beginning of his investing tenure, when the S&P; 500 dropped 14.7% in 1973, then 26.5% in 1974 (all of these figures are “total” returns, meaning price change plus dividend income).

By plodding along, investing $10,000 annually--a total of $200,000 over the 20 years--this investor saw his portfolio grow to $1.1 million.

The market’s average annual return in that 1972-92 period was 11.3%, according to data tracker Ibbotson Associates. If the portfolio had consistently grown at that rate, it would have been worth $750,645 at the end of 1992.

Then how could our investor have had $1.1 million? If you’re just getting started when the market is taking its worst hits, you have less principal at risk, so you are taking your losses at a comparatively good time.

Based on the market’s historical performance, you can expect that the longer your portfolio languishes, the better it will fare in the future, when you presumably have more invested. Again, this is assuming you own a well-diversified portfolio.

Naturally, you’d make much more by jumping into the market before the good years begin and jumping out before the bad years begin. But no one has been able to consistently predict market turns.

The moral of this story: If you’re in your 20s or 30s--or even your early 40s--and you haven’t invested much for retirement, now may be a good time to start.

Certainly, the market could get worse before it gets better. Stock prices still are historically high relative to per-share earnings--another classic indicator of market value, or the lack thereof.

For that reason alone you shouldn’t be putting the rent money into stocks.

But for very-long-term money, a bad stretch in the market has usually spelled opportunity.