The Impact of Market Crashes on Long-Term Expected Returns

After a significant market decline, many investors wonder if they might benefit from higher expected returns by investing post-crash. This analysis examines how a 10% or 20% market drop might affect long-term investment outcomes based on historical data.

Market Crashes and Subsequent Returns

When markets experience sudden downturns, they create potential entry points with improved return prospects. However, the magnitude of this opportunity depends on several factors including the severity of the crash, recovery patterns, and long-term market dynamics.

10% Market Corrections

Market corrections of 10% or more occur with surprising regularity. Since 1980, the S&P 500 has experienced a drop of 10% or more in 47% of calendar years37. Despite this frequency, the market has maintained an average annual return of approximately 13.3% over the same period3.

A 10% correction typically takes about five months to reach its bottom, with recovery occurring relatively quickly—around four months on average4. This rapid recovery pattern means that while investing after a 10% drop offers some advantage, the window to capitalize on lower prices is often brief.

Research indicates that in cases where a 10% correction occurs, investors who wait could gain about a 10% return benefit compared to those who invested before the correction12. However, this advantage must be weighed against the opportunity cost of waiting for corrections that don't materialize.

20% Market Crashes

A 20% or greater market decline (a bear market) represents a more significant opportunity but also comes with longer recovery periods. Historical data shows that bear markets have averaged 35.8% declines from peak to trough and typically last about a year and a half4.

Recovery from these larger crashes takes considerably longer—about two years and two months on average4. The COVID-19 crash of 2020 was an exception, with the market recovering in just eight months despite a 34% decline2.

One important consideration is that nominal recovery periods don't account for inflation. When adjusted for inflation, real recovery times are substantially longer. For instance, after the 2000 "tech wreck," inflation totaled 35.7%, prolonging the real recovery in purchasing power by an additional seven years and nine months beyond the nominal recovery5.

Expected Return Enhancement

While it's intuitive to assume that buying at lower prices should increase expected returns, quantifying this advantage is complex. The empirical evidence presents several key insights:

Short-term advantage: Following a 10% correction, historical data suggests an approximate 10% return benefit compared to pre-correction investing12.
V-shaped recovery pattern: Markets typically follow a V-shaped pattern around recessions, with sharply negative returns heading into downturns and strong recoveries as recessions unfold9. This pattern indicates that the window to capitalize on lower prices may be brief.
Post-crash positive momentum: Following severe market declines, returns tend to be significantly positive. One year after each of the S&P 500's 10 worst one-day drops, the index delivered double-digit positive returns in all but one instance6.
Compounding disadvantage: The opportunity cost of waiting for crashes that don't materialize is substantial. In scenarios where a 10% correction doesn't occur within three years (44% of cases), the opportunity cost averages about 30%12.

When considering these factors collectively, the expected return enhancement from investing after a 10% crash might be around 10%, while a 20% crash could potentially offer a greater advantage in the short term. However, this advantage diminishes over longer time horizons as market recoveries progress.

The Risk of Waiting for Crashes

A critical consideration is the risk associated with waiting for market crashes before investing. Multiple studies demonstrate that attempting to time the market by waiting for corrections frequently underperforms a strategy of immediate investment:

Missing best market days: Missing just the 10 best days in the market over a 20-year period reduces annualized returns from 9.7% to 5.5%14. This risk is significant because the best days often occur during volatile periods when investors might be hesitant to enter the market.
Net expected cost: When factoring both the benefit of investing after a correction (10%) and the opportunity cost when corrections don't materialize (30%), the net expected cost of waiting is approximately 8%12.
Time in market versus timing: Across multiple studies, lump-sum investing outperforms dollar-cost averaging in approximately 80.6% of periods since 199719, suggesting that immediate market exposure typically produces better long-term results than attempting to time entry points.

Investment Strategies Following Market Declines

If a significant market decline does occur, several investment approaches can help optimize returns:

Lump-Sum Versus Phased Investment

During normal market conditions, lump-sum investing typically outperforms dollar-cost averaging. However, following significant market declines, this relationship changes:

In drawdowns of 10-20%, phased investment approaches (such as investing over six tranches) outperformed lump-sum strategies 92% of the time18.
For drawdowns exceeding 20%, all phased-in approaches maintained positive returns while lump-sum returns often turned negative18.

A "fixed income first" approach—where investors deploy cash into bonds before gradually shifting to equities—has shown particular effectiveness following severe market declines18.

Industry-Specific Considerations

Not all sectors recover uniformly after market crashes. Research indicates that high-beta stocks (more volatile than the market) lose more value during crashes but tend to gain more during post-crash recoveries8.

During specific crashes, certain industries have experienced stronger rebounds after being hit hardest—high-tech stocks following the 1997 crash and manufacturing stocks after the 2008 crash showed evidence of investor overreaction and subsequent recovery8.

Conclusion

Based on historical patterns, a 10% market crash might increase expected returns by approximately 10% in the short term, while a 20% crash could offer potentially greater enhancement. However, these advantages tend to diminish over longer time horizons as markets recover.

The evidence suggests that while investing after crashes can provide improved return prospects, the risks of waiting for crashes often outweigh the benefits. Market timing strategies historically underperform strategies that maintain consistent market exposure, primarily due to the difficulty of predicting market movements and the risk of missing strong recovery periods.

For long-term investors, the most reliable approach appears to be maintaining consistent market exposure rather than attempting to time entry points around potential crashes. As Warren Buffett's famous adage suggests, it often pays to "be fearful when others are greedy, and greedy when others are fearful"—but implementing this wisdom requires being in the market when fear arises, not watching from the sidelines.

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Historically, a 10% market correction creates conditions for elevated long-term returns due to improved valuations, though the exact magnitude depends on recovery patterns and investment timing. Based on historical evidence from major corrections:

Post-crash return enhancement: Investors entering after a 10% decline typically gain a 10% return advantage compared to pre-correction entry points37. For example, buying after the COVID-19 crash (34% drop) allowed investors to capture a 15.6% annual return during the recovery phase39.
Valuation mechanics: A 10% price decline increases future earnings yield. If earnings remain stable, this effectively raises expected returns. For instance:
- Pre-crash: $100 investment with 13% average return → $113 in one year
- Post-10% crash: $90 entry point → $101.7 (13% return) + additional 11.1% recovery gain → combined 24.1% first-year return3 7
Long-term compounding: While immediate post-crash returns spike, the effect dilutes over time. A 10% crash might add ~1-2% annually to long-term expectations when spread across a 10-year horizon, potentially pushing returns toward 14-15%79.

However, this assumes reinvestment during the downturn and excludes inflation impacts. Real-world outcomes vary depending on economic context – the 2008 crash required 6 years for full recovery, while 2020's rebound took months29.

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Ansgar John / Sinaas

Friday, March 28, 2025

Vlaggetjesweken vlaggetjesdag voordeel , higher expected stock market returns after crashes. Perplexity deep research

The Impact of Market Crashes on Long-Term Expected Returns

Market Crashes and Subsequent Returns

10% Market Corrections

20% Market Crashes

Expected Return Enhancement

The Risk of Waiting for Crashes

Investment Strategies Following Market Declines

Lump-Sum Versus Phased Investment

Industry-Specific Considerations

Conclusion

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