Are You Smarter Than a Fifth Grader?

Brendan goes over a very basic mathematical concept when it comes to the stock market, and it uses a calculation you probably learned in fifth grade math. Once you grasp this concept it becomes obvious why staying invested in the stock market has historically been a good move.



Topics Discussed:

  • Percentage losses versus percentage gains

  • Historic rates of return after a market drop

  • Possible benefits of sitting tight

Transcript:

Hi, and welcome to another edition of Coffee with Brendan, today's episode, we're going to, half-jokingly call it so you’re smarter than a fifth grader because this concept, this mathematical concept is a very important concept to really wrap your head around when it comes to the market. So let's jump right in, this one will probably be a little bit shorter than my other ones, just simply because it's a pretty simple concept, but very important one, as I mentioned, to be aware of.


So let's take a look at the markets. You've already seen this chart a number of times I've shown this chart to people in my meetings, but also, in this Coffee with Brendan series. This is what the market has done since the year 1996. And so you see that it peaked in March of 2000 went down 49% bottomed out at 777, in October 2002, took five years to recover, but it did recover 100%. And then from October 2007 to march 2009, it went down another 57%. And then it came back came back in 2012. So we've already gone through this, that these two are the two of the most uncomfortable times, at least in my career, and certainly in recent history that people can remember and in probably don't remember very fondly.


But the key here is that when the market goes down, the market doesn't come back the same amount. So like you see here, the market went down 49% and came back 100%. Usually, when people say you know, when people think about this, they say Oh, well the market was down 49 and came back 49. That's not the case. And this is just simple math. So let's just switch gears and go to an Excel spreadsheet, one of my favorite things in the whole world. And take a look at why this actually is.


So if we go here, this is 2009 to 2000 - excuse me 2007 to 2009. And what this is pretty much saying is that between 2007-2009 is that the market started - market being s&p 500 - at 1565 and went down 800 points to 677. So if you just simply take that 888 and divide that into the original number, the market dropped 57%. So but it doesn't come back 57% It came back 131%. So how is that? Well, if we started 677, and we ended it that original number 1565 - And it's still change 888 - the difference here is that your your starting point is now 677. So again, going back to our fifth grade algebra or not even algebra math class, when you're calculating percent differences, you have to base it off of the start number, not on the bigger number. And so therefore you're now talking about it growing 888 points off of the 677, which works out to 131%. Long story short, when the market goes down 57%, the market comes back 131%.


And so if we just take a look at where we are today, very sneaky, I hit that one. This is where we are right now. So if you believe that the market will come back, and that's the key here, if you believe the market will come back, then this is where we started at the beginning of the year, January - 4797. It has ended or at least I should say, as of September 30 2022, the market is down 1200 points. And so similarly if we say if it dropped 1200 points off of that 4797, you've lost about 25%. Now we don't know and that's where the big question marks are here. We don't know when when or if the market will come back. But again, if history repeats itself, and it does come back, it goes from this low we hit in on September 30 and comes back to the high that we're at January. That's a 1200 point gain off of the 3586 which means that there's a 34% rate of return.


So why do I bring this up and why is this so important for investors? Well, it's pretty much right here. I'll show you one more thing and I'm apologize for bouncing around. But this is the limits of my expertise here, so. So if we go to this page here, what this is pretty much saying is that just like I said a moment ago, it takes 35%, to get back to where we once were 4797. If it took two years, it's a 17% average rate of return on your money over that two year period. And if it takes three years, four years, or even five years, long story short, if you sell out of the market, and get into something else, you have to compare what the market performance would look like if you just sat tight and stayed there. So if you just sat tight and stayed there, and the market came back, you've pretty much built in a 35% rate of return. If you move it somewhere else, it has to make more than 35% over that same timeframe, in order for that move to be a better move for you. And so again, it's just a key key investment concept.


And so another way of looking at this is, okay, let's say that you have a bunch of cash just sitting around, you know, and I have clients that have big chunks of cash sitting around. And I'm always trying to get them to put it into the market, and especially now because the market right now is down. And if the market just simply comes back to where it was January of this year, you're baking in some pretty significant rates of return, that being in the bag, you just cannot rival.


And so again, this was a short and sweet one. But it's super duper important to realize that if you just simply sit tight, and the market comes back, like it has 100% of the times in the history of this of the market, you're building in some really, really good rates of return. So I would make the argument that it would be very challenging to find a better rate of return than what you're looking at right here By taking money out of the market today and putting it into something else. Or conversely, if you have cash just sitting around or you've been waiting, waiting, waiting, waiting to put money into the market, because the market was has been so high for the last several years. Well, again, this is the type of rate of return that's built in.


And if we go back to the original chart that I was looking at, look at the rates of return that the market experienced. And again, I went through this in a in a prior coffee with Brendan, but if you look at this, you know, this is where we once were, this would have been a great, great time to have invested because your money if you would put cash in on March 9 2009, it would have experienced a four times multiple over the 12 years from 2008, when you would have put the money in to where it peaked at least initially right before COVID and February. And that's that 400% rate of return this is all met. So I'm not making any kind of I'm not sticking my head out on this one at all. I'm not saying that the market is coming back. But if it does, like it has 100% of the time, you're looking at some pretty significant rates of return by either sitting tight and not making any panic moves or, two, taking money that's sitting on the sidelines or sitting in some kind of dormant investment and putting it into the market at this time.


So again, short and sweet. Don't have too much more for today on this kind of dreary Tuesday that we're looking at today. But at least it's not snowing here in Massachusetts as it is in some parts of the country right now on October 18, which is the date that I'm actually shooting this. So hope you have a great day and look forward to the next time we chat. Take care.


This is a hypothetical example and is not representative of any specific investment. Your results may vary.


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