5 Market Crashes, 9 Lessons On Risk Tolerance.

This is an update of a post I wrote 2 years ago, after the sharp drop (and quick recovery) of March 2020. I thought it was worth revisiting, especially since I haven’t properly learnt lesson #2: don’t look.

I have had the dubious pleasure of investing through a number of market crashes over the years. Each one has taught me something about my risk tolerance, and I hope that the lessons I have learned may be helpful to you. If only to show you what not to do.

I decided not to present each past market drop chronologically, but rather to discuss each drop in terms of my personal risk tolerance, from least to most. Please keep in mind that, of course, your risk tolerance will change depending on your age and life circumstances.

1. The Dot-com Bust

At the time of the dot-com bust (March 2000, for those who might not have been old enough to notice at the time), I was in medical school, relying on my investments to cover the costs of living.

I distinctly remember working out at the school gym, and watching MSNBC as they reported on the steep drop in the stock market. I thought to myself: crap, there go my living expenses.

The wiser me of today looks back and sees that I was keeping money that I needed in the short term (to pay for rent and groceries) in an investment meant for the longer term. Stocks were described, at the time, as being suitable for a 3 year investing horizon. People nowadays are suggesting a 5 year horizon, as in: if you need the money in 5 years or less, don’t put it in the stock market.

Relying on money invested in the stock market for short term needs represented a gross error in my asset allocation.

Had I had a year’s worth of spending safely in cash, or cash equivalents (back then you could actually get reasonable rates on CDs), my risk tolerance would have been much higher. That is to say, I could have kept the rest of my money in the stock market, without any concern about whether the NASDAQ dropped 78% or not. Because I did not have that safety net, I had very little risk tolerance. I needed that money and could not tolerate seeing the market drop.

Lesson 1: Money you need soon doesn’t belong in the stock market.

Put another way: cash in the bank gives you a nice cozy armchair feeling of security. Only with your back protected (or your rent covered) can you feel more comfortable with aggressive investment allocations.

2. The Great Recession

In the years leading up to the Great Recession, I was doing well: a single woman, making attending money as an outpatient PCP. In 2007, I was busy at work, making good bonuses, and doing very well financially.

Portrait of a woman in black with a large hat
Not my actual staff photo.

I was living in a nice apartment, probably the nicest place I’ve ever lived on my own; I had fulfilled my short term post-residency financial plans (a new phone and a new-to-me car); and had started to splurge a little bit on travel. I was saving money regularly in my 403(b), investing in stocks in a taxable account, and also putting money in a 529 plan for my only nephew. I had a lot of cash saved for an eventual down payment on a house.

Then 2008 rolled around.

Two months after Lehman Brothers was let fail in September, I was in a new job, having just spent a ton of money moving . The economy was going down the toilet and I was the last person hired (aka, usually the first person fired).

Doom and gloom was in the air. Everything was changing, and it seemed none of it was for the better.

I wasn’t working very hard (in primary care, your workload is usually pathetic the first year or two of practice), and I clearly was not earning my salary. I was convinced I would be let go, though my bosses assured me otherwise.

Despite my fears, I carried on with contributing to my 403(b) every month, as soon as I was allowed to.

However, I didn’t have the confidence to put money into my nephew’s 529. I did not want to put in my once or twice year contribution, and then kick myself as his account lost 20 or 30%. I didn’t want to ask myself: you dummy, why didn’t you just keep it in cash? It took a while for me to feel comfortable contributing again, and I missed out on investing at the market bottom for him.

Every time I checked my taxable investment account, it was dropping. I didn’t contribute there for a long time either.

During this time, at least I still had a nice cash cushion (my house down payment fund), though I didn’t think of it as my emergency fund. After all, in my mind it was to buy a house. Nevertheless, every time I checked my account balances, at least I had one account that wasn’t falling.

I took away 3 lessons:

Lesson 2: Do not check your investment totals. All it did, back in 2009-2010, was give me anxiety. This anxiety kept me from investing for my nephew’s college costs at a time when I would have gotten some of the best returns possible.

Lesson 3: With the safety and confidence of gainful employment and an emergency fund (as I had then), I could manage a higher risk tolerance than I could in 2000. Put another way, my human capital allocation (my ability to work and earn a paycheck) was strong, so that I could manage more risk with my investment capital.

Many years later, I could look back and wish that I had had the confidence to put more money away for my nephew in 2009. But, as they say, hindsight is 20/20. I did not have the stomach for it back then.

Lesson 4: Continue to invest in college funds for my niece and nephews if the market crashes.

3. Black Monday (October 1987)

I approached this crash with a sense of security born of youth and privilege.

I was a very young adult, still supported by my parents, which meant I could afford to lose money with very little repercussions. Of course, I would be very upset to lose money I had saved up over years, but really, the stakes were low. I would still be able to eat, have a roof over my head, and go to college. You could say my risk tolerance was nearly infinite.

So when the stock market dropped by 22%, I had the luxury of seeing this as an opportunity to buy a stock on sale. With my father’s help, I bought one company, whose price was most certainly on sale, and which [in 2020] is currently selling for about 16-times the purchase price.

Overall, this wasn’t a very big investment, as I was young, and didn’t have much saved from my summer jobs.

Lesson 5: You really can buy stocks on sale.

Lesson 6 (a corollary of lesson 1): Your risk tolerance can be high if you don’t have any real responsibilities.

4. 2020 and COVID-19

Over the a period of several months, the stock market was all over the place. Evening news reports talked about the biggest loss the Dow has ever seen, followed by huge 1-day gains, followed by another huge loss. Etc.

I’d learned my lesson from the dot-com bust, and I had plenty of cash put away. I had an emergency fund, in case I lost my job (a worry, during the early days, of closing clinics and furloughed staff), and a little more to take care of those irregular costs (like property taxes, and car insurance). I did not have to rely on my investments to pay rent or for groceries.

I’d learned my lesson from the Great Recession, and did not look at my investment portfolio valuations. I didn’t need that sort of anxiety, on top of all the other anxiety that comes with dealing with a viral pandemic with an unclear fatality rate and no successful treatment (at the time).

However, since I was still working and drawing a salary, I continued to invest monthly; through dollar cost averaging, I definitely came out ahead over the following 2 years (Physician on Fire has a nice post explaining why a bear market can be good for investors). My human capital let me run a higher risk tolerance.

Remembering my regrets from 2008, I am added more money in the 529 plans for my niece and nephews.

Additionally, I was feeling secure enough to offer significant support for others, both family and strangers.

A trio of young ladies in a field, one giving money to a young girl. They are accompanied by a little dog, who is staring down 2 cows.
This wasn’t quite my style of giving, but I suppose as long as the effect is the same…

Some conclusions from 2020

Two years ago, I had the following final thoughts:

One. My risk tolerance now, while I am still earning a good living, is high. Assuming that we all get through this disaster, I may have plans to cut back more, or even retire, before the next bear market comes along.

Under those conditions, my risk tolerance will be quite a bit lower.

In the next few years, as the stock market recovers, it may behoove me to move some of my portfolio into less risky investments (bonds and cash). We will see if I remember to do this in 2022 or 2023.

Two. Also lesson 7: This pandemic has been a reminder that money really isn’t everything. Even with plenty of cash, I can’t assure myself or my family of safety, health, or even happiness. However, I can be generous, and help those who need a hand, whether family or just people in my community.

5. 2022

I’m not sure what we will call this financial period in a few years.

Right now, it looks like: when the chickens came home to roost. Financial support from pandemic policies are coming to an end, inflation is coming back, and–oh yes–international politics are heating up and we still have a pandemic.

The stock market is declining regularly, and with it, my portfolio.

I had been watching my nest egg more carefully, as it rose at the end of 2021.

I was thinking of cutting back significantly this year or next, and possibly planning my early exit. At the time, my biggest obstacle was fulfilling my obligations to my practice, and deciding if I truly was ready to hang up the stethoscope.

In theory, my plans haven’t changed. I am still working, still fulfilling my obligations to the practice, still deciding what professional goals I want to achieve before I stop practicing medicine.

In actual fact, I have been checking my portfolio daily, and feeling a little worse each day I see red numbers. In my mind, the day that I can retire (if I choose) is receding into the future.

The lessons I am taking away from this stock market decline so far:

Lesson 8: Your risk tolerance changes over time. As my working career comes closer to the end, I really do need to have more cash (or equivalents) available; money that is not subject to the vagaries of the investment market. Otherwise, my retirement date will depend on the whims of the market and not on my personal needs.

Lesson 9, which is really lesson 2 (but I keep having to relearn it): Stop looking at your investment totals. If you are still working, and earning enough to live on, watching the numbers go down will only affect your mood for the worse. If you have food on the table and are investing at relative lows, it’s all good.

Were you investing through some of these crashes? What lessons did you take away from your experiences?