A record no one wants to see broken

Posted by on October 19, 2012 @ 8:47 am in Investing

Records are made to be broken, or so goes an old saying.

One record that I hope stands forever was set 25 years ago. The U.S. stock market dropped almost 23% in a single day—October 19, 1987.

The Dow Jones Industrial Average fell 508 points, or 22.6%, on what was quickly dubbed “Black Monday.” Even that huge percentage understates what investors felt. In the three trading days leading up to the crash, the Dow average had fallen more than 10%. The weekend of October 17 and 18 gave commentators and investors plenty of time to worry about what would happen next.

I remember those events pretty well. I was the business editor of The Philadelphia Inquirer at the time, and our staff scrambled to report on the market decline and its implications. The memory of the crash is even more vivid for Vanguard veterans and, no doubt, for investors who endured it.

One thing those Vanguard veterans recently pointed out to me was that there had been a market slide early in 1987 that had a large and lasting impact on how we serve our clients. In the spring of 1987, after several years of generally declining interest rates, rates rose sharply. Bond prices fell, as they always do when interest rates rise. Investors—many of whom had not experienced a decline in bond prices—were frightened, and many called to talk with their Vanguard representatives. The volume of calls outpaced our ability to answer them quickly.

From that bad experience came a very good thing: Vanguard’s “Swiss Army”—a contingent of crew trained to volunteer and help answer phones or process transactions when volumes surge. Thanks to the experience from the bond market “crash” in the spring, the Swiss Army was in place on October 19, 1987.

“People from all over Vanguard jumped on the phones to help answer calls from nervous shareholders,” recalled Nancy Keller, who was a client representative 25 years ago and who—appropriately enough—is now Swiss Army coordinator. “Because of their effort, we were able to be there for our shareholders.”

Steve Vargo was in orientation along with two dozen other crew members who started work at Vanguard on October 19. He remembered wondering if he had just made a colossal blunder. “Some of the ‘nervous new hires’ were sure they’d be laid off, but there were no layoffs,” he said.

Another October ’87 veteran, Felicia Rivers, said investors’ emotions “ranged from philosophical to full-bore panicked.”

However, despite Wall Street’s free fall, most investors did not dump their stock holdings. Holding on turned out to be the right move. The Dow average regained 16.6% over the next two trading days.

Of course, you needn’t be an “old-timer” to have scars from market slumps. In the past 13 years, investors have seen two bear markets that took stock prices down by more than 50%.

Finance theory—and it’s been pretty well borne out by history—says that this risk of periodic sharp declines is why stocks should provide higher long-term returns than less volatile investments. The trick to collecting this “risk premium” is being able to stick with stocks over the long term. And that’s why those Vanguard veterans of the ’87 crash are strong believers in balance—holding bonds and cash, as well as stocks, so they aren’t totally blindsided by the unexpected.

Notes: All investing is subject to risk, including possible loss of principal. Diversification does not ensure a profit or protect against a loss.

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