Can you manage if the stock market falls by 50% taking years to recover?

Published: February 27, 2021 at 10:57 am

Last Updated on February 12, 2022 at 6:14 pm

Imagine this scenario: the stock market falls by about 50% – not suddenly over a few days but over months and months, say over three years. Since there is no sudden fall, there is no sudden recovery either. The market stays underwater (below the previous all-time high) for the next five years. Can you manage this situation financially? The question has nothing to do with managing emotions; we will know this only if/when it happens. Can your net worth, your income, your expenses handle this situation?

As you read the scenario, if you thought:

  • “Is this possible?”, the answer is, most definitely!
  • “I will just invest more!” It is not as easy as that. A fall is an opportunity only if the recovery is fast. If it takes years, the risk increases with time lost.
  • “surely the govt will step in and do something?”, I am not discussing if the govt would manage (their interests). I am asking “can we manage?”. Very different questions!
  • If you are part of the “this is volatility, not risk” club or
  • if you thought, “ok, so this is possible, but the probability is extremely low, is it not?” meaning you reject this as unlikely, then we should part ways right here.
  • “Are you talking about a Japan-like equity market?” not exactly. A few years of the market trading below its all-time high is quite common!

If you asked, “what is the point?” then I hope this exercise will provide some perspective on whether our investments rely on hope or an actual plan with a fail-safe in place. Perhaps when the market actually falls by 50% and recovery takes forever, we might remember this exercise.

Before we begin, let us appreciate that the situation mentioned above can take an emotional toll on even the most experienced investor because it does not happen every day. How we would react is, at best, unknown; at worse, we are likely to panic (perhaps justifiably!).

Join over 32,000 readers and get free money management solutions delivered to your inbox! Subscribe to get posts via email!
🔥Enjoy massive discounts on our robo-advisory tool & courses! 🔥

We could ignore all the logic presented below if emotions rule our decisions. If we do not think of (and record) logical scenarios when the market is ‘up’, we eliminate even the little chance of reminding ourselves of it when the market is ‘down’.

The primary question to answer is, “will I still have a job?” “will I still have an income source?” This is the immediate need.  For many people, the answer would be no. How will I put food on the table? An emergency fund will not help – it is for a one-off use, not regular withdrawals. This is when all that talk and reading about “multiple sources of income” becomes most relevant!

Can I handle a 50% drop in equity plus years plus years lost in recovery? Emotionally I do not know, never been there; never done that. Financially, at the very least possible. If today my equity holdings reduced 50% in value, my financial independence status would drop from 50X to 32X (X = current annual expenses). I have assumed a 20% drop in my NPS corpus (this has 15% equity and gilts). My current asset allocation is about 60-63% equity, and the rest in debt (most of this in NPS).

If I was not retired (from gainful employment), I might let it ride and wait for recovery (remember we are wearing a theoretical logical hat, how I would react, no one knows).

If I were retired, I would scramble to change my asset allocation, fortify my income, reduce expenses, etc. This is the reason why the robo advisory template plans for guaranteed income for the first 15Y years in retirement, with the rest of the corpus managed in three buckets of low, medium and high risk.

Notice the importance of luck in all this. I imagine a 50% drop in equity from a 50X (total) corpus. This means that for the 12+ years that the corpus has been accumulating, it is sheer luck that a 50% drop did not occur (although I saw no returns for the first five years and at least two 20% plus drawdown events)

What would I have done if I had only 5X or 10X and lost 50% of equity (assuming it was at least about 40%). Loss of 50% is one thing; years to recover is another. If I am young, employed (or at least employable), then I can somehow survive. If I am in my 50s? Then I will be forced to become conservative.

My son‘s future portfolio: This has about 58% equity, and if the stock market falls by 50%, the overall corpus will drop by about 28-30%. I can still manage his college education. Again there are two factors at play: starting early (I started from 60% equity, 40% debt corpus a month before he was born. and is 11 now) and, as always, luck.

Let me reiterate. These are theoretical ways in which I could react. I do not know how I would respond, but I now have a document of possibilities ready. Will I remember or bother to read it then is another matter, but at least it is in place.

It is sheer luck that, at least in theory, I can manage the loss in value and, more importantly, time. I would urge you to think about this and share (on FB group Asan Ideas for Wealth) or on Twitter how you would cope. You can also comment on our YouTube community page.

Are there any lessons from this? People talk about the “power of compounding” and the importance of starting early. The truth is, starting early in the capital markets is the best ways to manage risk because most of us invest without a plan; we hope the markets will not fall that much or will not stay down for that long. By starting early, we maximise our chances of getting lucky too.  Even if we do not have a plan, to begin with, starting early could minimise “time loss”.

Now the question to ask is, “yes, luck matters, but can I provide some assistance to luck with a plan that is robust enough to handle lost value and time?” It will not be fool-proof, but can I at least attempt to install a fail-safe?

Yes, but we need to look at our portfolio in a different light and go beyond “I got 700% XIRR after 13 days of mutual fund investing”. Every year, I would recommend asking the following questions:

  • What is my portfolio worth? If I liquidate it today, “how long can I live off that?”, if it is for retirement or “what product or service can I afford?”, if it is for something else.
  • Are the return and inflation assumption made in the plan reasonable, or should I change then?
  • What corpus should I have by now as per my plan? What is the actual corpus? If the corpus is less, is the gap too much? If the gap keeps increasing, should I change my asset allocation to lower risk?
  • What is my strategy to derisk the portfolio? Can I lower risk so that no what returns the market throws at me, I have a reasonable chance of getting close to my target corpus?

By asking effective questions such as this, when the going is good, there is a reasonable chance that logic will not entirely abandon us when the going is bad.

If we plan well, we can (rightly) attribute the past to luck. If we do not plan, we will have to rely on luck in future.

Do share this article with your friends using the buttons below.

🔥Enjoy massive discounts on our courses, robo-advisory tool and exclusive investor circle! 🔥& join our community of 5000+ users!
Use our Robo-advisory Tool for a start-to-finish financial plan! More than 1,000 investors and advisors use this!
New Tool! => Track your mutual funds and stock investments with this Google Sheet!
We also publish monthly equity mutual funds, debt and hybrid mutual funds, index funds and ETF screeners and momentum, low-volatility stock screeners.
Follow Freefincal on Google News
Follow Freefincal on Google News
Subscribe to the freefincal Youtube Channel. Subscribe button courtesy: Vecteezy.
Subscribe to the freefincal Youtube Channel.
Follow freefincal on WhatsApp Channel
Follow freefincal on WhatsApp
Podcast: Let's Get RICH With PATTU! Every single Indian CAN grow their wealth! 
Listen to the Lets Get Rich with Pattu Podcast
Listen to the Let's Get Rich with Pattu Podcast
You can watch podcast episodes on the OfSpin Media Friends YouTube Channel.
Lets Get RICH With PATTU podcast on YouTube
Let's Get RICH With PATTU podcast on YouTube.
🔥Now Watch Let's Get Rich With Pattu தமிழில் (in Tamil)! 🔥
  • Do you have a comment about the above article? Reach out to us on Twitter: @freefincal or @pattufreefincal
  • Have a question? Subscribe to our newsletter using the form below.
  • Hit 'reply' to any email from us! We do not offer personalized investment advice. We can write a detailed article without mentioning your name if you have a generic question.

Join over 32,000 readers and get free money management solutions delivered to your inbox! Subscribe to get posts via email!

About The Author

Pattabiraman editor freefincalDr M. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. He has over ten years of experience publishing news analysis, research and financial product development. Connect with him via Twitter(X), Linkedin, or YouTube. Pattabiraman has co-authored three print books: (1) You can be rich too with goal-based investing (CNBC TV18) for DIY investors. (2) Gamechanger for young earners. (3) Chinchu Gets a Superpower! for kids. He has also written seven other free e-books on various money management topics. He is a patron and co-founder of “Fee-only India,” an organisation promoting unbiased, commission-free investment advice.
Our flagship course! Learn to manage your portfolio like a pro to achieve your goals regardless of market conditions! More than 3,000 investors and advisors are part of our exclusive community! Get clarity on how to plan for your goals and achieve the necessary corpus no matter the market condition is!! Watch the first lecture for free!  One-time payment! No recurring fees! Life-long access to videos! Reduce fear, uncertainty and doubt while investing! Learn how to plan for your goals before and after retirement with confidence.
Our new course!  Increase your income by getting people to pay for your skills! More than 700 salaried employees, entrepreneurs and financial advisors are part of our exclusive community! Learn how to get people to pay for your skills! Whether you are a professional or small business owner who wants more clients via online visibility or a salaried person wanting a side income or passive income, we will show you how to achieve this by showcasing your skills and building a community that trusts and pays you! (watch 1st lecture for free). One-time payment! No recurring fees! Life-long access to videos!   
Our new book for kids: “Chinchu Gets a Superpower!” is now available!
Both boy and girl version covers of Chinchu gets a superpower
Both the boy and girl-version covers of "Chinchu Gets a superpower".
Most investor problems can be traced to a lack of informed decision-making. We made bad decisions and money mistakes when we started earning and spent years undoing these mistakes. Why should our children go through the same pain? What is this book about? As parents, what would it be if we had to groom one ability in our children that is key not only to money management and investing but to any aspect of life? My answer: Sound Decision Making. So, in this book, we meet Chinchu, who is about to turn 10. What he wants for his birthday and how his parents plan for it, as well as teaching him several key ideas of decision-making and money management, is the narrative. What readers say!
Feedback from a young reader after reading Chinchu gets a Superpower (small version)
Feedback from a young reader after reading Chinchu gets a Superpower!
Must-read book even for adults! This is something that every parent should teach their kids right from their young age. The importance of money management and decision making based on their wants and needs. Very nicely written in simple terms. - Arun.
Buy the book: Chinchu gets a superpower for your child!
How to profit from content writing: Our new ebook is for those interested in getting side income via content writing. It is available at a 50% discount for Rs. 500 only!
Do you want to check if the market is overvalued or undervalued? Use our market valuation tool (it will work with any index!), or get the Tactical Buy/Sell timing tool!
We publish monthly mutual fund screeners and momentum, low-volatility stock screeners.
About freefincal & its content policy. Freefincal is a News Media Organization dedicated to providing original analysis, reports, reviews and insights on mutual funds, stocks, investing, retirement and personal finance developments. We do so without conflict of interest and bias. Follow us on Google News. Freefincal serves more than three million readers a year (5 million page views) with articles based only on factual information and detailed analysis by its authors. All statements made will be verified with credible and knowledgeable sources before publication. Freefincal does not publish paid articles, promotions, PR, satire or opinions without data. All opinions will be inferences backed by verifiable, reproducible evidence/data. Contact information: letters {at} freefincal {dot} com (sponsored posts or paid collaborations will not be entertained)
Connect with us on social media
Our publications

You Can Be Rich Too with Goal-Based Investing

You can be rich too with goal based investingPublished by CNBC TV18, this book is meant to help you ask the right questions and seek the correct answers, and since it comes with nine online calculators, you can also create custom solutions for your lifestyle! Get it now.
Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You Want Gamechanger: Forget Start-ups, Join Corporate and Still Live the Rich Life you wantThis book is meant for young earners to get their basics right from day one! It will also help you travel to exotic places at a low cost! Get it or gift it to a young earner.

Your Ultimate Guide to Travel

Travel-Training-Kit-Cover-new This is an in-depth dive into vacation planning, finding cheap flights, budget accommodation, what to do when travelling, and how travelling slowly is better financially and psychologically, with links to the web pages and hand-holding at every step. Get the pdf for Rs 300 (instant download)