What Is Market-Value Risk in Investing? - dummies

What Is Market-Value Risk in Investing?

By Eric Tyson

Although the stock market can help you build wealth, most people recognize that it can also drop substantially — by 10, 20, or 30 percent (or more) in a relatively short period of time. After peaking in 2000, US stocks, as measured by the large-company S&P 500 index, dropped about 50 percent by 2002. Stocks on the NASDAQ, which is heavily weighted toward technology stocks, plunged more than 76 percent from 2000 through 2002!

After a multiyear rebound, stocks peaked in 2007 and then dropped sharply during the “financial crisis” of 2008. From peak to bottom, US and global stocks dropped by 50-plus percent.

In a mere six weeks (from mid-July 1998 to early September 1998), large-company US stocks fell about 20 percent. An index of smaller-company US stocks dropped 33 percent over a slightly longer period of two and a half months.

If you think that the US stock market crash that occurred in the fall of 1987 was a big one (the market plunged 36 percent in a matter of weeks), take a look at the following table, which lists major declines over the past 100-plus years that were all worse than the 1987 crash. Note that two of these major declines happened in the 2000s: 2000 to 2002 and 2007 to 2009.

Largest US Stock Market Declines*

Period Size of Fall
1929–1932 89% (ouch!)
2007–2009 55%
1937–1942 52%
1906–1907 49%
1890–1896 47%
1919–1921 47%
1901–1903 46%
1973–1974 45%
1916–1917 40%
2000–2002 39%

* As measured by changes in the Dow Jones Industrial Average

Real estate exhibits similar unruly, annoying tendencies. Although real estate (like stocks) has been a terrific long-term investment, various real estate markets get clobbered from time to time.

US housing prices took a 25 percent tumble from the late 1920s to the mid-1930s. When the oil industry collapsed in the southern United States in the early 1980s, real estate prices took a beating in that area. Later in the 1980s and early 1990s, the northeastern United States became mired in a severe recession, and real estate prices fell by 20-plus percent in many areas. After peaking near 1990, many of the West Coast housing markets, especially those in California, experienced falling prices — dropping 20 percent or more in most areas by the mid-1990s. The Japanese real estate market crash also began around the time of the California market fall. Property prices in Japan collapsed more than 60 percent.

Declining US housing prices in the mid- to late 2000s garnered unprecedented attention. Some folks and pundits acted like it was the worst housing market ever. Foreclosures increased in part because of buyers who financed their home purchases with risky mortgages. Housing market conditions vary by area. For example, some portions of the Pacific Northwest and South actually appreciated during the mid- to late 2000s, while other markets experienced substantial declines.

After reading this, you may want to keep all your money in the bank — after all, you know you won’t lose your money, and you won’t have to be a nonstop worrier. Since the FDIC came into existence, no one has lost 20, 40, 60, or 80 percent of his bank-held savings vehicle within a few years (major losses prior to then did happen, though). But just letting your money sit around would be a mistake.

If you pass up the stock and real estate markets simply because of the potential market value risk, you miss out on a historic, time-tested method of building substantial wealth. Instead of seeing declines and market corrections as horrible things, view them as potential opportunities or “sales.” Try not to give in to the human emotions that often scare people away from buying something that others seem to be shunning.