The famous quote, “Life is what happens when you’re busy making other plans,” basically means – you can’t plan for everything. The quintessential example of this is when a global pandemic hit in 2020 and the stock market plunged roughly 30% seemingly overnight. It was unpredictable. Life happened to the entire world all at once.
We are emotional creatures, so it’s natural to experience a little (or let’s be honest, A LOT of) anxiety when your investments are hemorrhaging money. But it’s important to not react impulsively during these declines. Selling or making drastic portfolio changes in volatile times (and under duress) can screw up your investments even further.
Yes, negative stock market returns occur. You can expect to see at least a handful of down years during your investing career. But historical data shows that the positive years far outweigh the negative ones. But each and every time the market has experienced a crash, correction, or recession, the market has recovered.
In this article, we’re going to discuss what to do during a stock market crash, and how to steel our resolve in order to weather the financial storms that will inevitably arise.
What Defines a Stock Market Crash?
A stock market crash is simply an unanticipated or sudden drop of stock prices in the market—usually following an uptrend known as a bull market.
There are several reasons the stock market experiences crashes, such as economic changes, geopolitical issues, and external economic events. Events like world wars, global pandemics, and changes in government regimes could all lead to a major market downturn.
However, it’s important to keep in mind that the stock market has always bounced back after a crash.
Historical Stock Market Crashes
|1929||Market tanked due to a contracting economy and investor panic, causing the Great Depression, and bottomed out in 1932, more than 80% below peak prices. It took over 20 years to recover.|
|1971||An oil crisis, economic recession, and unlinking the dollar from gold all led to a market decline of 48%. It took 21 months to recover.|
|1987||Known as “Black Monday” the market plunged 25% due to market decline, investor panic, and early computerized trading gone awry. Market recovered within two years.|
|2000||The “dot-com bubble burst” dropped the market nearly 50% after a surge of investing and speculation in internet-related ventures during the 1990s and took nearly seven years to recover.|
|2008||Due to the housing bubble and subprime mortgage crisis, the market lost nearly 50% and some indexes took almost a decade to recover.|
|2020||The COVID-19 global pandemic caused the market to fall by over 30% but it rebounded in just six months.|
Investing in the stock market, over time, will help you build wealth in a meaningful way. But that doesn’t mean it’s a cake walk. When mayhem strikes the market, it often comes alongside other difficult events. That’s why it’s crucial to let history be our guide as investors. It helps us stay the course. If we zoom out and look at trends over multiple decades, this is what the stock market prices look like:
Things To Do When the Stock Market Crashes
As you can see from the chart above, stock market crashes are inevitable. Fear not! There are many potential beneficial moves that you should make when a crash occurs.
1. Don’t Believe the Hype
The media and hype culture we live in are prevalent. It doesn’t help that the 24-hour news cycle and media outlets are fueling any uncertainty you might have by proclaiming gloom and doom. And there’s no end to the “experts” they interview who will trumpet that same message. They tend to make something bad seem like the end of the world, especially financial news. So tune that junk out!
In the early days of the COVID-19 pandemic there were all sorts of outrageous assertions being made about the decline or eradication of various industries and markets. Some suggested that New York City would be in perpetual decline because of this raging virus. Did that happen? No way. NYC is thriving right now! Most of the other stark predictions ended up being way off too.
Remember what is true and stick with your plan, even in times of uncertainty. You don’t necessarily need to ignore the news completely, but don’t buy into the hype.
2. Don’t Panic Sell
When others start panic selling, take a deep breath and realize that crashes are a natural part of the long-term investing process.
Remember, a double-digit decline has occurred nearly every two years since 1950. If you can’t stomach a regular and substantial drop in your net worth you shouldn’t be investing your money, stick to savings. However, you might not realize that every single one of these 38 corrections in the S&P 500 has been succeeded by a new bull-market rally. In many cases, it only took weeks or a few months for the market to return to its previous highs.
If you sell your stock holdings in a panic, you’re likely to miss out on the recovery. Having your dollars sitting on the sidelines when the market roars back (which is impossible to predict) will hamper your financial progress. That is why it’s important to leave your investments in place, untouched, even when the market is looking grim.
3. Know Your Risk Tolerance
It’s always wise to be aware of your risk tolerance when it comes to the investments you choose. Knowing what you can stomach before market turmoil sets in will make it more likely that you’ll be able to stay the course. For example, if the prospect of your high-growth stocks losing over 50% is going to give you sleepless nights, you probably shouldn’t be invested 100% in growth stocks. On the flip side, investing conservatively doesn’t have to mean sacrificing significant wealth creation.
Back in 1980, if you had bought an S&P 500 tracking index, you would have gone through the worst single-day crash (1987), the dot-com bubble, the Great Recession, and the coronavirus crash. Even still, as a result of your patience and steadfastness, you would have earned an 11% average annual total return (including dividends) despite those declines. Not bad!
4. Do Nothing
Folks who panic sell during a crisis often regret it. Consider those who bailed in spring 2020, when the S&P 500 plummeted over 30% in the blink of an eye. Just a few months later, the COVID-19 market losses had been erased by the light-speed pandemic rally.
At the end of the year, the individuals who jumped ship missed out on gains of 65% from the bottom of the crash. That historic rally was impossible to predict when it felt like the world was collapsing in March.
The moral of the story is that if you are confident and comfortable with your investing strategy and the current makeup of your portfolio, don’t change your plans unless you have a valid reason. One way to help you do this very thing, to stay the course, is to create and write down your investing philosophy in a moment of calm. This gives you a physical reminder of how to react when times get tough.
5. Be Opportunistic and Consider Buying More
We all know the famous saying, “Buy low, sell high.” Following a crash, the market goes on sale and you can potentially benefit from purchasing more shares. And when you find yourself in a bear market where values are dropping like crazy, if you are in the wealth-building and growing stage, it’s time to buy!
It’s easier said than done. Buying more stocks when everyone else seems to be running for the exits isn’t an easy and intuitive choice. But it will pay off over time.
If you ask most old folks about their biggest investment mistakes, they’d tell you, “I wish I bought more when stocks were cheaper.” Stock market crashes are fantastic buying opportunities – if you have available funds.
6. Buy Bonds
Down markets present an opportunity for folks to consider something that novice investors might overlook – bond investing.
Government bonds are widely considered a safe investment, though they usually offer paltry returns compared to stocks and even other bonds. Nevertheless, during uncertain times, holding some government bonds can lessen your anxiety, given their history of unblemished repayment. If volatility makes you nervous, increasing your exposure to bonds can help.
7. Buy Dividend Stocks
Buying dividend stocks is also worth considering during a crash. Publicly traded companies that pay a dividend are almost always profitable. In comparison, dividend stocks have outperformed non-dividend payers over the long haul.
A J.P. Morgan report over a 40-year period (1972-2012) showed that dividend stocks averaged a 9.5% annual return, while the non-dividend stocks scored a measly 1.6% over the same period.
Bottom Line/Final Thoughts
No one can predict the future…we can only prepare for it the best we know how. As we’ve seen, stock market crashes are inevitable and they can vary widely depending on a variety of factors.
Watching your investments decline and lose value is disheartening. Nobody wants to see their portfolio take a massive dive. But remember that the more informed you are about the stock market, the easier it will be to avoid making hasty decisions.
Remember, crashes aren’t always bad news…they present individuals a unique opportunity to grow new wealth. But in order to take advantage of a crash, you must have a steady plan in place before it happens. And despite all the ups and downs, the yoyo-like gyrations that the market goes through, remember to zoom out. A diversified portfolio that is heavily weighted towards stocks is still the best path to build wealth for most Americans.
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**Feature picby Ruben Sukatendel on Unsplash
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