If you're brave, a black day on the stock market can have a silver lining.
Can you imagine a 15-year bull market? It isn't easy these days, but they do happen. There was one between 1974 and 1987. It came to a violent end 19 October 1987, when share prices fell 20% in a day.
We call that day Black Monday, and we're now approaching its 25th anniversary. That seems a long time ago now, especially with investors still reeling from a more recent and enduring market meltdown. But we can still learn a lot from that increasingly distant event. Such as…
I don't like Mondays
The weird thing about Black Monday is that there was no obvious reason for it. The Dow Jones plunged nearly 23% in a day. The FTSE 100 (UKX) fell 10% on the Monday, and another 12% on Tuesday. In Hong Kong and Australia, markets fell more than 40%.
Yet nobody agrees exactly why. Partly, it was down to the fact that shares were overvalued. The FTSE 100 had risen 37% since the start of the year.
Computer-driven dealing strategies may have aggravated the rise and fall. The US budget and trade deficits, and higher interest rates, were also blamed.
But there was no obvious 'Lehmans moment'. Black Monday just happened.
Keep your head
That was then and this is now, but there are still plenty of lessons we can learn from that stock market bloodbath.
First, don't panic. When markets are crashing around your ears, the temptation is to cut and run. By selling, you will only crystallise your losses. You then you face the tricky decision of timing your entry back into the market. If you fluff that, and you probably will, you will end up a two-way loser (as anybody who sold between the crash of autumn 2008 and rally of March 2009 will testify).
Sometimes, you just have to sit these things out.
Think long
Crashes don't matter. Yes, they feel hellish at the time, but the moment passes. As Tom Stevenson at Fidelity Investments has pointed out: "The 1987 crash looks insignificant on a long-term chart today even though, at the time, it felt like the end of the world."
Stevenson was in Hong Kong when the crash happened. The local stock market shut for a week. That's the danger with emerging markets. They can be difficult to escape in an emergency.
The recovery will come
A crash captures everybody's attention. The steady road to recovery rarely hits the headlines.
Markets got over the Black Monday blues relatively quickly, ending the year 2% higher than they began. Within two years, they had recaptured their pre-meltdown peaks.
If only markets had recovered as quickly from the 2008 crash. The key difference is that the underlying economy was in pretty robust shape in 1987. It isn't now.
Yet there is one common factor, too. In both cases, share prices want to get back to where they were before. Look at how today's market has shrugged off macroeconomic and geopolitical worries to enjoy a bullish summer.
There may be plenty of volatility ahead, but those animal spirits can't be suppressed for long.
Income beats growth
Here's another lesson. Never underestimate the power of the dividend. Stock market growth is a precarious thing, it can reverse itself in a day. But those dividends, once paid, are yours to keep.
And they keep rolling up, no matter what share prices have done that day. If you're investing for the long term, and you really should be, dividends will deliver more than half of your total return.
Let's look at the very long term. Say you had invested £100 in the UK stock market in 1899. If you have spent all your dividends, it would be worth £22,239 in today's money, according to the Barclays Equity Gilt study. But if you had reinvested them, it would be worth a massive £1,639,368.
Always bet on black
Black Monday also reminds us that the worst time to invest is when stock markets have risen sharply, and the best time is in the subsequent mayhem.
I shouldn't admit this, but part of me longs for another Black Monday. I have a little cash sitting around, and I would love to toss it into a market that had just fallen 20%.
I would use it to buy solid blue chips that got sold off in the panic mayhem. Names such as BHP Billiton (LSE: BLT), Diageo (LSE: DGE), GlaxoSmithKline (LSE: GSK), Reckitt Benckiser (LSE: RB), Rolls-Royce (LSE: RR), Royal Dutch Shell (LSE: RDSB), SSE (LSE: SSE), Tesco (LSE: TSCO), Unilever (LSE: ULVR) and Vodafone (LSE: VOD). They would all sit very nicely in my portfolio, especially if I bought them at a discount.
That's the final lesson of Black Monday. Stock markets fall, sometimes for no obvious reason. But in the long run, they always recover.
If you're brave, a black day on the stock market can have a silver lining.
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> Harvey owns shares in BHP Billiton, Diageo, Glaxo, Royal Dutch Shell and Vodafone. He doesn't own any other shares mentioned in this article. The Motley Fool owns shares in Tesco.
