Declines and recovery
Ten-percent declines occur about once a year on average; declines over forty percent occur a handful of times per century. Recovery periods have ranged from months to decades.
Anyone investing should know three orders of magnitude. Small declines of about ten percent occur in broad stock markets roughly once a year on long-run average. They're not an event, they're normal operation.
Medium declines of twenty percent or more occur every few years. Severe declines of forty to over eighty percent occurred several times over the last century: 1929 to 1932, after 2000, and 2007 to 2009.
Recovery time varies enormously. After the spring 2020 crash, it took months. After 1929, it took roughly twenty-five years in nominal terms and without dividends to reach the old high again.
The most important sentence about all this: these numbers aren't an argument against stocks. They're the reason why money with a short time horizon has no business there, and why the emergency fund comes before the brokerage account.
The distribution of declines roughly follows a pattern where frequency falls sharply with depth, but the tails of the distribution are considerably heavier than a normal distribution would suggest. Claims derived from historical frequencies therefore systematically understate the probability of very large events.
For recovery time, the basis of calculation matters a great deal. Figures excluding dividends and inflation adjustment produce considerably longer periods than figures including both. For the period after 1929, common figures range from roughly seven and a half to twenty-five years, depending on the measure. Both are mathematically correct.
For planning purposes, what matters isn't the expected value, it's the unfavorable case. A time horizon should be chosen so that even a recovery period at the upper end of the historical range doesn't force a sale. That's the quantitative basis for the rule of thumb that money needed within three years doesn't belong in volatile assets.
Summary
- A ten-percent decline is normal operation, not the exception.
- Historical recovery periods ranged from months to over two decades.
- Plan for the unfavorable case, not the average.
Did you get it?
How often do ten-percent declines occur?
In broad stock markets, roughly once a year on long-run average.
Why do different recovery times circulate for the period after 1929?
Because they depend on whether dividends and inflation are included. Both figures are correct.
What should the investment horizon be based on?
The unfavorable case, not the average, so no forced sale becomes necessary.
Sources and further reading
- Long-run price series of broad stock indices; figures on recovery time after 1929 vary depending on whether dividends and inflation are accounted for.
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