The Lessons of 'Black Monday'

The 1987 crash seemed catastrophic at the time but didn't derail the long-term investor

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On Oct. 19, 1987, the Dow Jones index plummeted 22.62 percent, some 508 points, to close at 1,738.41, in one record trading session.

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Two decades ago, on Oct. 19, 1987, the Dow Jones industrial average plunged 508 points. The 22.6 percent decline is still the stock market's biggest one-day loss ever in percentage terms, equal to a 3,200-point drop today. At the time, Americans were dealing with a falling dollar, a new Federal Reserve chairman, and a global war (albeit a "Cold" one) that bred uncertainty. Looked at that way, October 2007 sounds eerily similar to October 1987. So what should today's investor know about "Black Monday," 1987?

The crash was of historic proportions, but today Black Monday might be better remembered for what didn't happen. Not only did the United States not go into a depression, as after 1929's "Black Thursday" and "Black Tuesday," but the day barely caused a blip in long-term economic growth. Alan Skrainka, chief market strategist at Edward Jones, remembers the surprise at how underwhelming the crash ended up being: "It was over almost immediately. The wisest words uttered that week were from John Templeton: 'The bear market might already be over.' How could this man make such a bold statement when everybody else was pretty much in a panic?"

It might seem only natural to panic when unprecedented declines occur. While the crash in 1987 had impacts outside the United States—the London and Hong Kong markets, for example, had fallen 45.8 and 26.4 percent, respectively, by the end of that October—some analysts say that today's more globalized economy would make future Black Mondays even more far reaching. "If the Dow were to drop a similar percentage today, we would likely trigger a global flight to quality selling of equities. I would hazard to guess that a U.S. Black Monday now would lead to a global Black Tuesday," says Jason Hsu, director of research and investment management at Research Affiliates.

As the weak housing market and a credit crunch unsettle today's stock market, it's worth looking at the real costs of Black Monday. Consider this: If you had a strong stomach and invested $10,000 on the Tuesday after Black Monday in 1987, you'd have roughly $133,000 today. Yet even if you had terrible timing and invested $10,000 on the Friday before Black Monday, your investment would still have grown to $98,000.

Now that $35,000 difference is no small potatoes. (In fact, it's an SUV.) Yet even those unlucky investors who bought big right before the crash have still earned an outstanding 12.1 percent annual rate of return versus the 13.8 percent enjoyed by those perfect market timers.

Skrainka says that the real lesson from Black Monday is that one can't—and shouldn't—try to beat the market by predicting where it will go at any given time. "Base your investments on principles, not predictions. The three most important principles are look to the long term, properly diversify your portfolio, and focus on good-quality investments," he says.

Panicking is the last thing you want to do in a market crash. "Market declines are often the long-term investor's friend because they provide an opportunity to buy investments at a lower price," Skrainka adds. "It's the investor who sells in a panic who's the big loser in a market decline."

It goes to show that investors shouldn't focus too much on the market's daily ups and downs—even when those downs seem catastrophic. For buy-and-hold investors, Black Monday just wasn't as menacing as its name implies.