Sunday, January 30, 2011

A simplified crash case history


As a follow-up on "How to deal with a stock market crash" let's do the numbers in a spreadsheet. Our only investment is in our favourite S&P/TSX60 iShares ETF symbol: XIU. This ETF represents a diversified portfolio of the 60 largest companies on the TSX, they are typically blue chips (other than Nortel which was in the far past made up part of the TSX), represent most market segments and they pay dividend which we like to reinvest. Although the dividends fluctuate, currently they are $0.45 per year per unit.

I mention Nortel, because it illustrates that sometimes even the TSX and TSX60 can get out of whack. During the High Tech boom of early 2000, Nortel was such a proportional large component of the TSX and the TSX60 that its value distorted those indexes and when it crashed in 2001, the indexes crashed much lower than the market excluding Nortel. Thus many investors wanted an ETF of the TSX that limited exposure to a single company. Hence the creation of the 'Capped TSX' ETF (symbol XIC).

For your information, the current top 10 stock holdings of the TSX60 (XIU) are shown in Table 1. The price history of the TSX60 iShares over the past 3 years are shown in figure 2. If you owned a $10,000 portfolio holding only XIU units in January 2008, it would contain 514.14 shares (See spreadsheet in Figure 3). At the depth of the Great Recession, that portfolio was worth 514.14 * $11.75 = $6,041.13 plus dividends earned over 5 quarters or $283.80. If you panicked and sold your portfolio at that point you would have lost: $10,000 - $6,041.13 - 283.80 = 3,675.07. WOW!! That is a 37% loss in one year. Heck, no wonder no-one sane of mind wants to invest in the stock market! Yep that would have been the end of my early retirement dream! Run, the world is coming to an end!!
Table 1 – Top 10 stock holdings of XIU as of January 2011

Eh, wait a minute. IF you hadn't sold then today in January your portfolio would have been worth: 514.14 X $19.38 PLUS Dividends worth $692.93 or a total of $10,656.94 and an annual return of 2.1% - Not great but no losses either. You're back on the retirement road.

But suppose you had $5000 cash in 2009 and bought perfectly timed at the bottom of the market? Don't bother, that is like winning the lottery. But what if you started buying in $1000 chunks after the main crash over a 3 month period? The spreadsheet in Fig 3 shows that your timing was far from perfect and that you never bought at the perfect bottom. The average purchase price was $12.07 not the bottom price of 11.75, but you bought 414.42 shares. Hé, that is strange! You bought more shares than if you bought the shares all at once for $12.07 – in that case you would have bought 414.39 shares. This is nickel and diming, but still…

I digress. So we kept our cool, we didn't believe that this time we really have the end of the world and so we bought 5 times after the crash when everyone shouted 'doom and gloom'. Now, a year and half later we own 928.53 (see Figure 3) shares worth $19.38 each and we received $1054.69 in dividends. Total profit: $4,049.53 or an annual average return of 8.3%! That while we are still climbing our wall of worry! I guess, you get the point.

Figure 2, XIU price chart over past 3 years from GlobeinvestorGOLD.


Figure 3 – Crash Scenaro Spreadsheet.

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