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The 3.5% Solution

October 13, 2015

The 3.5% Solution: Buying Fear

Monday August 24th was a roller coaster day in the stock market. The Dow opened the day 1,000 points lower than its Friday closing price. By midday, stocks had rallied to nearly recover that entire decline, only to roll over in the afternoon. In the end, the S&P 500 index was down just shy of 4% and is now technically in a correction, having fallen 11.2% below the all-time high hit on May 21. 
In the past, I have told you that big, one-day market declines were often great buying opportunities for long-term investors. Given that it has been over three years since 500 Index fell by 3.5% or more in a single day, I thought this would be an opportune time to take a look back at how investors fared following these alarming days.

Since the second half of 1983, which is as far back as my daily pricing data on 500 Index goes, there have been 54 days when the fund fell 3.5% or more in a single trading session. There's nothing magic about my 3.5% threshold, though in the past that number seems to have really set the alarm bells ringing.

Buying these extreme declines takes a cool head and a long-term focus, but has paid off for disciplined investors. In the table below, I've listed the 54 days over nearly three decades when 500 Index fell by 3.5% or more, ranked from largest to smallest decline. And then I've shown the gains earned over the ensuing 12 months. What you may notice is that there have been nine one-year periods following a 3.5% or greater decline in 500 Index when investors lost money. Those nine declines averaged -7.7%. Not great. Of course, there were also 45 periods when gains were earned—they averaged 27.6%. Nice.

Buying a Dip Is a Good Idea

Worst Days Since June 1983 
500 Index Change 
500 Index Return One Year Later 
10/19/1987 -20.5% 37.7% 
10/15/2008 -9.0% 27.7% 
12/1/2008 -8.9% 27.7% 
9/29/2008 -8.8% -9.6% 
10/26/1987 -8.3% 28.1% 
10/9/2008 -7.6% 18.1% 
10/27/1997 -6.9% 41.1% 
8/31/1998 -6.8% -11.7% 
1/8/1988 -6.7% 40.3% 
11/20/2008 -6.7% -5.1% 
8/8/2011 -6.7% 28.8% 
11/19/2008 -6.1% 18.4% 
10/22/2008 -6.1% 0.2% 
10/13/1989 -6.0% 49.3% 
4/14/2000 -5.8% 46.3% 
10/7/2008 -5.7% 26.7% 
1/20/2009 -5.3% 17.7% 
11/5/2008 -5.2% 46.9% 
10/16/1987 -5.2% 23.5% 
11/12/2008 -5.1% 20.6% 
11/6/2008 -5.0% 68.1% 
2/10/2009 -4.9% 1.1% 
9/17/2001 -4.9% 0.7% 
9/11/1986 -4.8% 27.0% 
8/4/2011 -4.8% 25.1% 
9/17/2008 -4.7% 16.1% 
9/15/2008 -4.7% 38.6% 
3/2/2009 -4.6% -9.4% 
2/17/2009 -4.5% 32.5% 
8/18/2011 -4.5% 52.4% 
4/14/1988 -4.4% 19.2% 
8/10/2011 -4.4% 52.2% 
3/12/2001 -4.3% 12.8% 
4/20/2009 -4.3% 13.5% 
3/5/2009 -4.2% 19.2% 
11/30/1987 -4.2% 20.3% 
11/14/2008 -4.2% 28.5% 
9/3/2002 -4.1% 21.0% 
10/2/2008 -4.0% 62.7% 
5/20/2010 -3.9% 25.0% 
10/22/1987 -3.9% -1.3% 
10/6/2008 -3.9% 41.9% 
8/27/1998 -3.8% -7.1% 
1/4/2000 -3.8% 8.8% 
9/22/2008 -3.8% -5.0% 
7/19/2002 -3.8% 32.2% 
11/9/2011 -3.7% 0.5% 
11/15/1991 -3.6% 27.1% 
8/4/1998 -3.6% 23.8% 
12/3/1987 -3.5% 24.2% 
3/24/2003 -3.5% 32.4% 
3/30/2009 -3.5% 15.8% 
2/23/2009 -3.5% -7.2% 
2/27/2007 -3.5% -13.0%

For many investors, just sticking with a well-thought out investment strategy in the face of large one-day declines (and the Chicken Little headlines that follow) may feel like an act of courage. But it seems pretty clear that those with a bit more confidence (and spare cash) who make the rational choice to put some money to work in the market when fear is pervasive can come out winners.

*The Standard & Poor’s 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly