It may seem far-fetched to suggest the FTSE 100 could fall to 3,939 points. After all, such a slump would take it down to a level not much above the lows of the bear market 10 years ago. And it would represent a fall of 50% from last May’s all-time high of just over 7,877 points. However, the brutal truth is that stock markets — and investors’ share portfolios — can and do halve in value from time to time.
The world’s greatest living investor, multi-billionaire Warren Buffett, pulls no punches on the subject. He has said: “Unless you can watch your stock holding decline by 50% without becoming panic-stricken, you should not be in the stock market.”
As an octogenarian, Buffett has more first-hand experience than most of those of those in the market. In his most recent annual letter to shareholders of his Berkshire Hathaway investment company, he wrote that Berkshire shares had suffered four “truly major dips” in their 53-year history. He included a table showing “the gory details”…
|March 1973 – January 1975||59.1|
|June 1998 – March 2000||48.9|
|September 2008 – March 2009||50.7|
On average, Berkshire’s share price crashed nearly 50% every 13.25 years. You might be thinking “the world’s greatest living investor? You’ve got to be kidding?” But I kid you not. However, despite suffering these not infrequent slumps, Buffett’s shareholders have enjoyed an overall gain of 2,404,748% over the 53 years — a 20.9% compound annual increase in their wealth.
Now, Buffett’s returns have been well ahead of markets, such as the US’s S&P 500 index or the UK’s FTSE 100 index. But like his Berkshire portfolio, these indexes have always bounced back from crashes and gone on to make new highs. Indeed, over long periods, shares (equities) have outperformed other assets, such as bonds, property and cash. The price of the superior returns is enduring the big crashes. As Buffett has said: “No one can tell you when these will happen. The light can at any time go from green to red without pausing at yellow.”
It’s entirely possible the FTSE 100 could crash to 3,939 points. Equally, its current drop to around 1,000 points below its previous high could just be a minor decline, or ‘correction’. And it could rapidly ascend to a new high of 8,000 points or more.
No one knows what the markets will do in the short run. What we do know is that in the long term, investors in equities are likely to build their wealth to a significantly higher level than investors in other assets. Indeed, for many people, the stock market can provide a route to financial independence in later life.
With this in mind, stock market crashes shouldn’t induce panic in a rational investor. They should be a cause for rejoicing. A 50% fall in a stock means you’re able to buy twice as many shares for the same cash outlay. In the long-term, such purchases are likely to deliver some of the biggest returns you’ll enjoy. As such, by making the most of market corrections and crashes, you could achieve financial independence much sooner than you would otherwise have been able to do.
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The Motley Fool UK owns shares of and has recommended Berkshire Hathaway (B shares). Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.