Start Investing… and Pray for a Crash!?!?

My title sounds like very strange- who wants to see their investments crash?   However, if a crash is going to happen it is much better for you for it to happen sooner and for the recovery to happen later! Let’s explore a few graphs to see when and how much it could matter.

Lump Sum

Let’s first consider a lump sum starting with $10,000 what happens in three cases:

  • Blue – Uniform 8% Returns
  • Red –  Boom (133.3% gain) then Crash (-50%)
  • Green – Crash (-50%) then Boom (133.3% gain)

lumpsum.png

  • All 3 cases end with exactly the same amount

This isn’t an accident because multiplication is commutative, the order you multiply doesn’t matter: 3*5 = 5*3 = 15.   However, most of us don’t do all of our investing in one giant sum.

Periodic Investments

Most of us put away some amount every year over a long period of time; let’s look at an example where we invest $1000 each year for 10 years with the same returns as above:periodic.png

  • Totals Very Different:
    • $26,812
    • $7,317
    • $13,486

Multiplication with addition (or subtraction) is NOT commutative, for example (5+1)*2+1 = 13 while (2+1)*5+1= 16.  The order matters!  It matters a lot in investing- if the crash happens first then the boom the total is over three times more than the boom first and then the crash.   So when you start investing you should pray that the biggest crash happens immediately!

5 Responses to “Start Investing… and Pray for a Crash!?!?”

  1. JoeTaxpayer says:

    I see the wildly different results.
    You used a single year return of 133% and a single crash year of 50%?
    Didn’t this conversation start with a +10%, -5%, +22% and -3% mix of years?

    The -50 can certainly happen, but I think the +133 really throws off the reality of the exercise.
    Joe

  2. Rick Francis says:

    Joe,
    Thanks for commenting! You are correct I am using different numbers, why? The original example didn’t have a crash so I picked the simplest example that had one year with a crash and another (insanely) booming year that gave the same average return- that is why the lump sum returns are the same as the uniform 8% returns.

    The main points aren’t changed if the boom is just one or a few years: The order makes a big difference, and you want the crash first. I ran the numbers for three years of 39.4% gains and one -50% loss:
    Crash first: $8,110 Crash Last: $25,200 ratio 3.11. The surprising message is still the same- start investing and pray for a crash!

    -Rick

  3. Monevator says:

    This is why young investors should have been smiling most of the year. Instead, commentators and 99% of financial bloggers have been banging on about being cautious and “waiting to see if the gains hold” which is muppetry.

    Crash+Money+Time=Wealth!

  4. I love the idea you left on my blog btw, about the salary? What a great way to make sure she saves her own money for her stuff, and you can both track your own expenses

    I hate joint accounts — I know people say they work for them, but I’d rather track my own expenses and cut a cheque for BF.

    I do agree that the crash really does make stocks bounce back hardier than before, but I’d hope to be investing at the BOTTOM of the crash so I can profit from the uptake 😉

  5. Rick Francis says:

    Thanks for commenting!

    @Monevator
    I think you bring up a very good point- wealth builds faster during crashes but people don’t like crashes because they feel pain seeing the paper losses. However, as long as we don’t convert those paper losses to real losses they shouldn’t be a cause for real pain.

    @FB
    I was happy to contribute an idea to your blog- I will have to make a post on it.

    I wish I could predict the bottom of a crash or even the peak of a boom- either could make a fortune quickly! However, if you invest every month you can be sure you will be investing very near the bottom- whenever it comes no crystal ball required!

    -Rick Francis

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