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Many stock investors are too young to remember Black Monday in October 1987 — why that’s a problem

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At some point over the next century, the stock market will lose more than 20% of its value in a single day. Maybe this doesn’t seem like useful advice, but the fact is that you’re kidding yourself if you think market crashes of such magnitude won’t happen again.

This sobering thought coincides with the 33rd anniversary of the 1987 U.S. stock market crash. On Oct. 19, 1987 — Black Monday — the Dow Jones Industrial Average
DJIA,
+0.39%

  lost 22.6%. It was the worst one-day percentage drop in U.S. stock market history. If a similarly-sized crash were to occur today, it would take about 6,500 points off the Dow in just one trading day.

Many regulatory reforms were instituted in the wake of the 1987 crash (as well as following other big subsequent drops, such as the so-called Flash Crash in May 2010). As a result, many investors have comforted themselves that another crash won’t happen.

That’s false comfort, according to research conducted by Xavier Gabaix, an economics professor at Harvard University. Two decades ago, along with three physicists at Boston College, he derived a formula that predicts the frequency of big daily changes over long periods of time. Though that frequency is low, it isn’t zero.

Read: This is the last chart investors need to see ahead of the ‘Black Monday’ market crash anniversary

Gabaix and his fellow researchers presented their research in December 2002 in the scientific journal Nature. To appreciate the model’s forecasting ability, consider that from that date until now — a period of 17.8 years — the formula would have predicted that there would be three days in which the market rose or fell by at least 10%. How many such days has the S&P 500
SPX,
+0.01%

 experienced since December 2002? Three.

This casts a different light on the huge volatility the stock market experienced in March 2020 as the stock market reacted to the COVID-19 pandemic — including the S&P 500’s 12% plunge last March 16. People’s natural reaction at the time was to focus on the historically unique and idiosyncratic causes of that crash. While understandable, this reaction also overlooked the reality that a drop of such magnitude was inevitable, sooner or later.

Since a 17.8-year period is not long enough to illustrate the predicted frequency of plunges as big as the 1987 Crash, the chart below focuses on the past century. Notice that the researchers’ model does an impressively good job of matching what actually happened.

To be sure, the researchers’ model doesn’t predict when these big daily market changes will take place. It instead specifies their frequency over long periods. So it’s entirely possible that Wall Street could go for decades without experiencing another crash like 1987’s, or suffer another one in the next year. The point of the model is that, when it does happen, we shouldn’t be surprised.

There’s a loose analogy here with pandemics. Scientists have been predicting for years that a pandemic was not a matter of if, but when. Yet, since the odds of a pandemic in any given year were so small, it was hard to get many people interested in planning for how to react when the inevitable came to pass. In retrospect, it’s clear that we all would have been well served by better planning.

The same goes for investing. It’s been more than 30 years since the 1987 Crash. People who belong to generations Y and Z were either not born at that time or not old enough to have any real memories of it. Most Gen Xers were not even out of college. No wonder it’s difficult to get most of us to spend much time imagining how we might arrange our portfolios to survive another crash.

In other words, today’s market is dominated by investors who are too young to remember the 1987 crash. I’m reminded of what Adam Smith, the pseudonymous author of the late 1960s classic book “The Money Game,” called a “kids’ market.” He used that phrase to refer to speculative bull markets in which the advisers and traders making the most money are those too young to remember prior crashes. “Memory can get in the way of such a jolly market,” Smith wrote. 

Smith described a friend of his on Wall Street called “The Great Winfield,” who exploited kids’ markets by only hiring investment managers who were not yet 30 years of age: “The strength of my kids is that they are too young to remember anything bad, and they are making so much money that they feel invincible. Now you know and I know that one day the orchestra will stop playing and the wind will rattle through the broken window panes, and the anticipation of this freezes [the rest of] us” who are old enough to remember.”

You might object to this analogy on the grounds that the stock market in March suffered its worst waterfall decline in U.S. history. Surely those memories are still fresh? But that decline is not what Winfield had in mind, since the stock market so quickly recovered. Today’s “kid” investors have filed away their memories of what happened in March under the category of “brief pause in the market’s inexorable march to new highs.” That’s hardly the kind of memory the anticipation of which “freezes” us.

Contrast this year with what happened between January 1973 and January 1985. At the end of that 12-year period, according to data from Yale University finance professor (and Nobel laureate) Robert Shiller, the stock market was no higher than where it was at the beginning on a dividend-adjusted and inflation-adjusted basis. Investors who lived through that dozen-year period were so traumatized that many swore of equities for the rest of their lives. The 1987 stock market crash had a similarly traumatic effect.

So if you are old enough to remember the 1987 Crash, memory will serve you well as you judge what kind of risk is appropriate. If you aren’t old enough, then you need to pay especially close attention to the academic studies which conclude that another crash is someday inevitable.

Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at mark@hulbertratings.com

More: Value stocks are poised to crush growth stocks after the presidential election

Plus:  The stock market’s strength tells us less about the true state of the economy than at almost any other time over the last five decades



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‘I could live on my Social Security and still save money’: This 66-year-old left Chicago for ‘calming’ Costa Rica — where he now plans to live indefinitely

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Editor’s note: This article was first published in September 2019.

A school break changed 66-year-old Martin Farber’s life forever.

In 2007, his daughter — who at the time was attending Illinois State University — decided she wanted to spend a college holiday volunteering in Costa Rica and staying with a local family, he explains. She came home raving about the experience, so, in 2008, Farber — who at the time was living in Evanston, Ill., just outside Chicago, and selling cars — took his first trip there.

“It was a big surprise to me — bumpy roads, dogs barking in the streets,” he says. “I wasn’t enamored at first.”

But as his daughter began traveling there more and eventually moved there for a year, he took additional trips to Costa Rica. It quickly grew on him — in particular, the people. “The Costa Rican people are warm, open and friendly. I felt less invisible in a strange country in a strange town where I didn’t speak the language than I did in Evanston.”

And the more time he spent there, the more it impacted him: “On one of my trips there, I thought: My daughter’s life makes more sense than mine,” he says. “There was nothing wrong with my life, but I felt that my life was out of context with who I’d become. … I would have bills and make money to pay them, but that had ceased to be satisfying,” he recalls. “I knew I needed to change my life — there was no more joy in what I was doing.”

What’s more, when he’d return from his Costa Rica trips, people noticed. “I would come back, and my friends and therapist would say: You seem better after you go,” he says with a laugh.

A view from the hot springs near Martin Farber’s home in Costa Rica.


Martin Farber

So in 2014, he packed up and moved to Orosi — a picturesque, lush small town with waterfalls and hot springs a little over an hour’s drive from San Jose — promising himself he’d stay for two years. It’s been five, and he now plans to stay in Costa Rica indefinitely. (Though Farber notes that, to him, “it’s not a retirement; it’s a chance to lead a new and different life.”)

Here’s what his life is like, from costs to health care to residency to everyday life:

The cost: While many expats spend way more living in Costa Rica, Farber says: “I could live on my Social Security and still save money.” He says “a person can live on $1,200 per month, two people on $2,000.” The key, he says, is to live more like he does and as the Costa Ricans do — in a modest home, eating local food and purchasing local goods.

Indeed, Farber himself spends just $300 a month for rent (he rents a home from a friend who moved recently and gave him a good deal), roughly $225 a month on groceries and just $50 a month total on water and electricity (the temperate climate in Orosi means you rarely need heat or air conditioning). The veteran Volkswagen
VOW,
+0.96%

 
VLKAF,
+0.98%

salesman saves money by not owning a car (those over 65 ride municipal buses for free), which can be a significant expense in Costa Rica; for his cellphone, “I pay as I go … roughly $10 may last me a couple weeks or more,” he says, adding that “many people handle there their cellphones this way. You can get them recharged anywhere.”

His major expense is travel: He goes back to the U.S. to visit his mother in Florida several times a year and lately has spent part of the summer in Chicago helping out a friend with a dealership there. He also spends a good amount of money on health care. He says that while flights can be had for as little as $350 roundtrip during offseasons, the cost can be much higher the rest of the year.

In the saddle.


Martin Farber

Health care: Farber, who has permanent resident status in Costa Rica, says he pays about $90 per month to participate in the country’s health-care system — adding that the health care he’s received has been very good. (A 2018 study of health-care quality and access in more than 190 nations ranked Costa Rica No. 62.)

When he developed a detached retina, though, he paid for the procedure out of pocket so that he didn’t have to wait for the required surgery, he says — adding that the entire procedure cost him about $5,000. “I would have had to have waited four days,” he says, if he had not paid to expedite matters. “That might have been fine, but it might not.” And he adds that the quality of care depends on where you get it in the country.

Lifestyle: Though Farber says that he “moved here with no goals and no agenda,” he’s found plenty to do. “I take Spanish lessons two days a week for two hours a day. It’s been great. I never thought I would acquire a usable language in my 60s,” he says. He also rides his bike all around the area, does some writing and belongs to a community group that undertakes projects to improve the area.

And he often simply takes in nature, which he says has been an essential part of why he feels calmer and more relaxed in Costa Rica than in the U.S. “I live at 3,000 feet but in a valley surrounded by coffee fields and lime trees and water. At night, if I open the windows, I can hear the river rushing by,” he says. “It is very calming … hundreds of trees everywhere … you know the Earth is alive.”

The historic Iglesia de San José de Orosi.


iStock

Cons: “I don’t want to overglorify. It’s not without its problems,” Farber says of Costa Rica. “There are social problems and downsides.” He notes that crime and petty theft can be a problem (“I am cautious,” he says of his approach) and seem to have increased since he moved there, and adds that he misses out on some cultural things because of where he lives. And, he says with a laugh, “I can’t order Thai food at 9 at night.” But, he adds: “These are trade-offs — in the afternoon, I get to walk in the coffee fields and see flocks of parrots.”

Residency: To qualify for Costa Rica’s pensionado visa, expats must prove that they have a pension of at least $1,000 coming in each month. (Here are the details of that program.) Once you have lived in Costa Rica for three years, you can apply for permanent residency. Farber used a lawyer to help him figure out the ins and outs of residency options; his entire path to permanent residency took about a year, he says.

The bottom line: “After five years I am still amazed and surprised that I made the decision to lead a life I never thought I would,” he says. And while he may not stay in Orosi forever — “the town doesn’t have an ambulance, [and] I don’t know what it will be like to be 80 there,” he says — he does plan to stay in Costa Rica in no small part because of the people and sense of community. “I have the feeling that life is good here,” he says. “It’s hard sometimes, but we are all in it together.”



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Mutual Funds Weekly: These money and investing tips can help you read the market’s signs and stay on your path

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