ELI5: How do we know the stock market will rebound?
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The stock market has long been a source of anxiety for many Americans. During times of social and economic crisis the stock market has been known to fluctuate so quickly it can make investors queasy. In fact, many may be scared off from investing in the stock market for fear of these very fluctuations.
Still, a Gallup poll found that 58% of Americans do own stocks. That’s a sizable chunk of the population, despite investing anxieties. This is likely because history shows that, despite some pretty severe crashes, long-term investors are still able to earn a respectable return.
While we can't know anything about the future with 100% certainty, there are certain things that are highly likely to occur. For example, the odds are extremely high that U.S. citizens will still be required to pay taxes on their income 30 years from today. Similarly, there's a strong likelihood that the stock market will also be higher at that point than it is today.
To understand why we can expect this, it's important to first understand how the stock market works. Here's what you need to know about stock market investing and why it's been a consistent winner for investors over the long haul.
The short version:
- The stock market has definitely seen its fair share of crashes since it began, but so far, it has always rebounded eventually.
- Long-term investors shouldn’t fear when the stock market drops since they can likely make up for any losses over time.
- Even with the risks, investing your money tends to pay out a much better return than savings accounts and other savings vehicles.
The stock market, briefly
In simplest terms, the stock market is a place where investors buy and sell stocks — or portions of public companies. So when you hear someone say they “own shares of Apple”, what they mean is they've purchased tiny slices of ownership in the company with the hopes of making money off the company's growth.
The history of the stock market goes all the way back to the 1700s with the creation of the Philadelphia Stock Exchange. It was founded to allow established businesses to raise more capital than they would be able to raise on their own. The New York Stock Exchange quickly followed suit and, today, it's the biggest exchange in the world, with a value of $24.5 trillion between all the companies that make it up. (And yes, that's a trillion with a T.)
What is a stock market crash?
Why would anyone be wary of such an old, revered institution like the stock market? One reason could be that throughout its long history, the stock market has crashed many times. These crashes can come with devastating results, plunging millions into debt and job loss — as was the case with the Great Recession of ‘08.
Typically driven by major world events like war and uncertainty, global pandemic, and irresponsible industry practices, stock market crashes are marked by the price of a majority of individual stocks dropping suddenly.
People start panicking, and they take their money out of the market and sell their stocks as quickly as possible for fear that they’ll never recover.
The start of COVID-19 created the 2020 crash, one of the more recent notable crashes. 2022 hasn’t fared much better, with the year kicking off with decades-high inflation rates and a war between Russia and Ukraine. This caused a sharp drop in stock market performance.
How do we know the market will rebound?
So far, as history has shown, the stock market has always recovered from a crash. Does that mean it will continue to do so forever? Not necessarily. It’s impossible to predict what might happen. We can only look at what has happened.
Thankfully, what we can glean from history bodes well for stock investors. In the case of the Great Recession, the market began dropping in December 2007, but started rebounding by the first quarter of 2009.
Bear markets — or times when we see a stock market decline — occur about every five and half years, so they’re definitely common. But bull markets, or times when the stock market starts ticking back up, happen at a higher frequency. In short, there are more good years than bad, historically.
Learn more: Bear vs. bull market
Should you ever panic during a market crash?
When something goes wrong, your first instinct is likely to leave the situation. The same is true for the stock market. When a crash occurs, many investors pull their investments and reinvest elsewhere. Generally, this is a terrible strategy. If you’re young and investing for retirement, stay the course.
For the S&P 500 (an index made up of the top 500 companies in the U.S.), when the market is down, stocks, on average drop by 36%. But they go up 114%, on average, during bull markets.
With more bull markets than bear markets (at least so far), the odds are in your favor for an eventual positive return.
Related: How to invest in the S&P 500 Index
Why investing is still a good income opportunity
If all investing comes with some amount of risk, is it even worth it? Simple math demonstrates that knowledgeable investing can earn you more than interest on a savings account ever could. Even your average high-yield savings accounts rarely offers anything close to 1%. Different types of investments have far outperformed this over time.
Here are a few investing categories and their average returns (just remember that these are general figures and your experience could be different):
- Stocks, on average, offer a 10% return.
- Real estate, on average, offers a 7% – 10% return.
- Bonds, on average, offer a 5% – 6% return.
How to choose what to invest in today
Choosing where to invest today when you have no idea what tomorrow holds can be a difficult task. The answer will differ depending on a number of factors, including:
When you want to see a return
Generally, safer investing options don’t offer a get rich quick option. If you’re investing for retirement, you’ll need a long-term strategy which will likely rely on more “traditional” investments like stocks, bonds, ETFs, and more. For those investing money to say, put a down payment on a home within the next five years, CDs and other low-risk investing options are better since you have less of a chance of losing money.
How risky you’re willing to be
All investing is inherently risky. Some investments are riskier than others, though — and that can be a good thing, or a bad thing. If you're investing long-term, you may benefit from the bigger upward swings of riskier growth stocks.
However, you'll want to be careful of how much you want to sink into a super-risky investment like cryptocurrency. With crypto prices plummeting constantly, it’s not a reliable investment for those who want a secure, long-term plan.
Don't know how much you can afford to invest in? Learn how to determine your risk tolerance
What you’ll need the money for
There are plenty of reasons people invest for shorter time frames. Planning for college, retirement, and other major milestones will require years of investing. Goals like paying for a wedding or paying a house down payment have shorter turnaround times since you’ll need the money after a few years.
How much money you're investing
If you don’t have a large amount to invest, some avenues like purchasing a real estate property won’t be within reach at this point in time. If you have a small amount of money consider more manageable investments like those offered by a robo-advisor. Many of these advisors have no minimum investment requirement.
There’s also a bit of personal preference associated with choosing your investments.
Popular investment options
When you've narrowed down your risk tolerance, time horizon and investment amount, you can start going over your options. Here are some of the major investment options available and who they’re best suited for:
- Consider stocks if…you’re investing for a long time for goals like retirement. The stock market provides an average return of 10%, making it a generally lucrative investment. Additionally, if you truly want to invest in one specific company, stocks are the way to do so.
- Consider ETFs or mutual funds if…you want an easy way to invest in multiple stocks and other investments all through one fund. Both ETFs and mutual funds provide a variety of investments, often organized by different goals and values. For example, there are funds that follow environmentally friendly investments or certain business sectors.
- Consider real estate if…you’re okay taking on some risk and you have a large chunk of money to pay upfront. Real estate investing is perhaps one of the more lucrative investing options, provided the person investing is armed with a lot of knowledge and maybe some luck. However, you may have to be a landlord to earn a high profit, and for some, that’s just not worth the time. Learn more about real estate investing here.
- Consider a robo advisor if…you want to invest but don’t have the know-how or desire to manage your own investments. The robo-advisor will manage your portfolio for you based on your risk tolerance. Sometimes you can even select some of the investment types you want or don’t want in your portfolio. You’ll need to pay a fee most of the time, but this might be worth it for many investors.
Related: 5 ways robo advisors reduce the cost of investing
- Consider crypto if…you’re willing to take on a LOT of risk, and are interested in the potential technology behind cryptocurrency. Crypto is a very new investment option that has an extremely volatile history. Be cautious, do your due diligence and never invest more than you can afford to lose.
It’s best to have a diversified portfolio with many different types of investments rather than putting all your eggs in one basket. This can ensure that even if one type of investment isn’t doing well, your whole portfolio isn’t in jeopardy.
Bottom line
While there’s no way to know for certain that your investments will even out after a stock market crash, history tells us that most portfolios do rebound.
Of course, the damage will depend on the types of investments you have — you’ll still need to pay attention to what you’re investing in, how much you’re putting in and whether it makes sense for when you’re hoping to withdraw.
However, those who invest for long periods of time are best off sitting back and letting their investments do the work.
Just getting your feet wet? Check out these intro guides to investing:
- How to invest $1,000: 8 best ways to invest right now
- The secrets of investing during a stock market crisis — how beginner and experienced investors react
- I fell for an investing scam…and here’s what I learned
- How can emotions affect your investing decisions?
Christopher Murray is a personal finance writer and editor who focuses on making content engaging and understandable for all generations.
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